Investment Returns Pummeled by QE2

Last week, the S&P 500 pulled back by less than 2% - certainly not sufficient to clear the overvalued, overbought, overbullish, rising-yields syndrome that we observe in the market, but enough to bring our estimate of S&P 500 10-year total returns from an expected 3.06% to an expected 3.25%.

From the standpoint of prospective investment returns, it is important to recognize that the main effect of quantitative easing has been to suppress the expected return on virtually all classes of investment to unusually weak levels. It's widely believed that somehow, QE2 has created all sorts of liquidity that is "sloshing" around the economy and "trying to find a home" in stocks, commodities, and other investments. But this is not how equilibrium works.

Here's how equilibrium does work. Every security that is issued has to be held by someone, in precisely the form in which it was created, until that security is retired. Period. That means that if the Fed creates $2.4 trillion in currency and bank reserves, somebody has to hold that money, in that form, until those liabilities are retired. The money ultimately can't go anywhere. If someone tries to get rid of their cash in order to buy stock, somebody else has to give up the stock and hold the cash. In the end, every share of stock that has been issued has to be held by somebody. Every money market security that has been issued has to be held by somebody. Every dollar bill that has been created has to be held by somebody. None of these instruments somehow "find a home" by going somewhere else or becoming something else. They are home.

Let me be clear - the additional monetary base created by the Fed certainly is "liquidity" from the standpoint of the banking system, and does amount to funding the U.S. deficit by printing money, until and unless the transactions are reversed. As I've noted previously, at what is approaching 16 cents of base money per dollar of GDP, there will also be significant inflationary risk in the event of even modest upward pressure on short term interest rates. The point, however, is that it is incoherent to say that this "cash on the sidelines" will somehow find a home in some other financial market, or anywhere else in a manner that makes it vanish from "the sidelines" - until it is explicitly retired by the Fed.

So what is the effect of creating an extra $600 billion dollars of monetary base by having the Fed purchase $600 billion dollars of Treasury debt? The same thing that happens anytime any security is issued. Somebody has to hold it, and the returns on all other assets have to shift by just enough to make everyone in the economy happy, at the margin, to hold the outstanding quantity of all of the securities that have been issued. In practice, the only way you can get people to willingly hold $2.4 trillion in non-interest bearing cash is to depress the return on all close substitutes to next to zero. So short-term Treasury bill yields have been pressed to nearly nothing.

Of course, people also look at risky assets and ask whether they might be able to get higher risk-adjusted returns by holding those instead. In order to make people happy to hold the outstanding quantity of zero return cash, the prospective returns on other risky securities have also collapsed (securities are a claim to future cash flows - as investors pay a higher price, they implicitly agree to accept a lower long-term return). In my view, this has gone on to an extent far beyond what is likely to be sustained, but thanks to eager speculation, the S&P 500 is now priced, by our estimates, to achieve annual returns of just 3.25% over the coming decade.

Likewise, all of those securities yielding zero or nearly zero returns have to compete with commodities. Here, the markets have responded to the massive deficits of world governments by increasing their expectations regarding inflation. Now, if you're looking at a zero nominal return on money-market instruments, as well as expected inflation over time, it's natural to start hoarding commodities. See, if you expect your dollars to buy fewer goods and services in the future, and you're not earning interest to make up for it, you'd prefer to stockpile goods right now. This, of course, has created terrible problems for people in less-developed countries, who are experiencing soaring prices for food and fuel, but commodity hoarding was a predictable outcome of QE2.

The real question is how high commodity prices have to rise until people are indifferent between holding non-interest bearing cash, and commodities that are elevated in price. The basic answer is that commodity prices have had to "overshoot" the expected future level of broad consumer prices by enough that both cash and commodities can now be expected to suffer a negative real return as measured against a broad basket of consumer goods. This sort of overshoot is necessary to make people indifferent between holding one versus another, and it restores equilibrium in the face of the negative real return available on money market securities. As with stock prices, I believe that this has already gone too far, but the civil unrest in the Middle East has certainly worsened the situation over the short-term.

This is a critical point - commodity prices tend to swing by a much greater amount than consumer prices. You can easily get periods where general consumer prices are advancing, yet commodities prices are advancing slower or even falling. In my view, QE2 has provoked an "overshooting" advance in commodities prices, which has been necessary because the Fed is holding real interest rates at negative levels. In the face of moderately higher consumer price inflation, coupled with short-term interest rates at zero, the only way to get people to be comfortable holding that much cash is to make the prospective returns on every possible alternative just as bad.

If investors don't understand that this is how QE2 is "working," they are likely to be as blindsided by the coming decade of weak investment returns as they've been over the past decade. It's notable that the weak returns achieved by the S&P 500 over the past decade were predictable, and our estimates of projected total returns have remained quite accurate in recent years. It bears repeating that our difficulty in 2009 was not that we viewed stocks as overvalued, but that we were forced to contemplate data from periods other than the post-war period, which had generally required much more stringent criteria for accepting market risk. At the 2009 lows, stocks were priced to achieve 10-year total returns in excess of 10% annually by our estimates. The problem is that similar expected returns were not sufficient to end prior declines during much lesser crises even in post-war data.

As for the Depression, stocks were priced to achieve negative 10-year returns, by our estimates, at the 1929 peak. After losing half their value, stocks were priced to achieve 10-year returns in excess of 10%. From there, stock prices dropped by an additional two-thirds before bottoming.

Whatever value was available at the 2009 lows is long gone. Our miss in 2009 was emphatically not the result of inaccurate valuation estimates - it was the result of having to contemplate data outside of the post-war period. I've extensively discussed the adjustments we've made (see recent commentaries as well as our semi-annual report). Still, there is nothing in recent data, nor long-term historical data, that creates meaningful doubt for us that stocks are priced to achieve bitterly small returns over the coming decade.

As it happened, much of the 10-year prospective returns that were priced into stocks at the 2009 low have been compressed into the advance since then. For long-term investors, there is now a great deal of risk with not much prospective return to compensate them at current prices. There will still be periods warranting at least a moderate exposure to market fluctuations based on shorter-term considerations, but with the market still characterized by an overvalued, overbought, overbullish, rising-yields syndrome, now is not one of them.

Savings, Investment and Credit Market Debt

Having discussed QE2, let's move on to the broader subject of "credit." Here also, there is a lot of confusion about how credit creation is related to real economic activity. My hope is that the following discussion will clarify some of these relationships. As usual, the best way to evaluate the merit of somebody's analysis is if they show you the data, so I'll also show you the data.

Let's start by considering an economy that produces 100 units of output. 80 are consumed, and 20 are saved as "investment goods" to increase the ability of the economy to produce more output in the future. On the "income" side, those 20 units would be considered to be "savings." On the "output" side, those 20 units would be classified as "investment."

Every good or service that is produced ends up being owned by someone, even if it is simply as unwanted inventory. In an economy where a price can be put on every good and service, and where that price is divided up into the amount earned (or sometimes lost) by those who produced that good and service, it is also an accounting identity that the total value of what the economy produces is equal to the total income of the people in the economy - this is why GDP can be calculated both in terms of "output" and in terms of "income." As a result, when one person saves, it follows that someone else in the economy either consumed more than they produced ("dissavings") or the saved output represented unconsumed investment goods. Net savings and investment are always equal, even if the "investment" represents involuntary accumulation of inventories as a result of production that fails to meet the preferences of consumers.

If the economy is specialized, so that workers, wealth-holders, factory owners and so forth are not identical individuals, the savings of some individuals have to be matched up with the desired investment or dissavings of other individuals. Credit is simply the means by which this transfer occurs. Suppose that each unit of output costs $1 in our simple economy. We need not trace every single transaction to know that ultimately, people will have earned $100 of income, consumed $80 of it, saved (net) $20 of it, then lent the $20 to others who bought the 20 units of "investment" output. In order to transfer or "intermediate" the savings, savers now get IOUs in the amount of $20, and the borrowers now owe IOUs in the amount of $20. The stack of IOUs in the economy thus represents amounts that have been intermediated from savers to borrowers. Broadly speaking (and with some important exceptions), the quantity of outstanding credit market debt measures the amount of net saving that has been transferred for the purpose of real investment over time.

Linking financial activity to real activity

A good way to understand the total quantity of credit market debt in the economy may be to think in terms of "opening," "closing," and "spread" transactions. In an "opening" transaction, someone produces a real good or service, earns money for doing so, saves some of it, and uses those savings to make a new loan to someone else in the economy. A "closing" transaction also transfers new savings that have resulted from the production of real goods and services, but in this case, the savings are used to pay off an existing loan to someone else in the economy. Finally, a "spread" transaction is one where someone in the middle essentially borrows from one person and lends to another. In this sort of transaction, the ultimate borrower and lender don't deal with each other, but are each a "counterparty" of the middleman.

It's useful to think of transactions in this way because it links what is happening in the real goods-and-services economy with that is happening in the debt markets. The economist Ludwig von Mises made a similar distinction when he talked about "commodity credit":

"Every serious discussion of the problem of credit expansion must start from the distinction between two classes of credit: commodity credit and circulation credit. Commodity credit is the transfer of savings from the hands of the original saver into those of the entrepreneurs who plan to use these funds in production. The original saver has saved money by not consuming what he could have consumed by spending it for consumption. He transfers purchasing power to the debtor and thus enables the latter to buy these nonconsumed commodities for use in further production. Thus, the amount of commodity credit is strictly limited by the amount of saving, i.e. abstention from consumption. Additional credit can only be granted to the extent that additional savings have been accumulated. The whole process does not affect the purchasing power of the monetary unit."

"Circulation credit is granted out of funds especially created for this purpose by the banks. It increases the amount of money substitutes, of things which are taken and spent by the public in the same way in which they deal with money proper. It increases the buying power of the debtors. The debtors enter the market of factors of production with an additional demand, which would not have existed except for the creation of such banknotes and deposits. It is the main tool of policies aiming at cheap or easy money."

Consider an "opening" transaction. Someone in the economy produces goods and services, but does not consume the income. That leaves unconsumed goods and services available to others in the economy. The saver takes the new income resulting from that production, and lends it to someone else. Now, one of two things can happen: 1) the borrower can use the proceeds for consumption, in which case savings are offset by dissavings, so you get an expansion of credit without any addition to real investment, or 2) the proceeds can be used to purchase investment goods.

If the economy has done its job well, individuals have an incentive to save, and the investment goods produced by the economy are desirable and add to future productivity. If the economy has failed to allocate production well, the investment goods end up being unwanted "inventory investment" and the savings are essentially used to finance their accumulation (think of a company having to borrow to cover payroll to produce goods that it was unable to sell). Worse, if the inventory is ultimately written off or goes bad, somebody is forced to book the loss of what they previously thought was income, producing "dissaving" and "disinvestment," and the economy goes on as if the misallocated output was never produced in the first place.

Keep in mind that the particular "story" will vary from case to case, and there may be intermediate transactions. But in the end all of this is an accounting identity. Exactly who ends up doing the borrowing, lending, saving, dissaving, and investment may be in question, but in aggregate, savings equal investment, income equals output, and everything that is produced ends up being consumed or held by someone.

What is important here is that stagnant or contracting credit market debt typically reflects an economy where there is little incentive to save, or where investment is misallocated to produce things that are not desired by consumers or businesses. Economic policies that both punish the incentive to save, and encourage the speculative misallocation of resources, however well-meaning, are hostile to economic growth and rising standards of living.

Yet even when credit market debt is expanding, it may not be favorable for the economy if the increase in debt is used to finance dissavings and consumption. In that case, you get an expansion in debt without a corresponding expansion in real investment and productive capacity. This is a dangerous game, because credit market debt can increase more rapidly than the real stock of productive investment assets in the economy that are able to service that debt. In the end, there will be hell to pay.

Sustainable Credit = Actual Savings Allocated to Productive Investment

Let's take the discussion above to real world data. The chart below presents the 4-year change in total credit market debt versus the 4-year total of gross domestic investment (which is also equal to gross domestic saving plus the savings we import from foreign countries to finance our economic activity). Note the two credit bubbles in the data. The first was in the late 1980's, which was followed by the savings-and-loan crisis. The second was the housing bubble that reached its peak in 2007, followed by the recent credit collapse. In both cases, the growth of debt rapidly outstripped real investment, indicating that debt was being taken on largely for the purposes of consumption. Savers were matched up with dissavers, creating a great deal of new debt, but no new net savings or investment. In addition, various forms of financial engineering created "repackaged" debt by simultaneously borrowing and lending, which created more debt securities and adding a great deal of "counterparty" risk to the economy. Neither of these credit bubbles ended well.

It's not clear whether Ben Bernanke will be successful in promoting a third bubble in credit, but it seems more likely that the Fed's interventions have done little except to defer the full resolution of the bubble we already had. Personally, I believe that the Fed's existing policies have set the financial markets up to experience persistent disruptions in the years ahead, so for all intents and purposes, he might as well have created a full scale bubble - the outcome for investors appears likely to be the same.

While the bubble in credit growth has clearly reversed, we would not be surprised to see a further deterioration in total credit market debt, accompanied by further stagnation in gross domestic investment for several more years. On that note, it's worth observing that after 5 quarters of positive growth, U.S. gross private domestic investment collapsed at an annualized rate of over 20%, both in real and nominal terms, during the last quarter of 2010. No wonder the U.S. economy only looks good with the help of deficit spending approaching 10% of GDP and what now amounts to trillions of dollars of Fed intervention.

Interestingly, the relationship between savings/investment and total credit market debt holds together fairly well in a cumulative sense since 1950. There are numerous factors (interest payments, retirement of debt, and so forth) that would need to be modeled explicitly in order to capture the precise relationship between cumulative savings/investment and growth of credit market debt. Still, to a first approximation, the two have grown very closely over the past 60 years. Importantly, credit market debt has increased far more rapidly than real savings and investment during the past decade, largely reflecting "cash-out" financing which withdrew equity from homes, as well as government deficit spending to finance consumption and military expenditures. Frankly, I also believe that a not-insignificant portion of outstanding credit market debt is essentially worthless, but is still carried on the books as if it has value. Overall, the recent bubble in credit was clearly not a reflection of productive saving and investment activity, and it is not clear that the economy has de-leveraged to the extent needed to put the burden of ongoing debt service in line with our productive means.

At present, the outstanding quantity of credit market debt represents about 3.5 times GDP. The chart below is from Flow-of-Funds data, and I should note that the Federal component does not include Treasury debt held by the Fed, the Social Security Administration, or other government agencies. While 3.5 times GDP seems like an unbelievably high figure, the analysis above suggests that most of this is well represented by productive investments that the economy has made over time. To the extent that a large proportion of this debt represents productive investments that the U.S. has made over time, the debt is perfectly desirable. Indeed, we are hopeful that the U.S. economy will produce and allocate far more savings to investment, funding new innovations and discoveries that will add to future growth and economic prosperity.

On the other hand, however, the gap is still too wide between the credit that has been extended and the productive capacity that we have accumulated. Much of that gap has emerged because we continue to punish saving by depressing the rate of return available to investors, while at the same time pursuing policies aimed at consumption rather than real investment, research & development, and other activity that would add to the productive capacity of the nation. Stimulating consumption and speculation have been the life-blood of government policy interventions over the past two years, yet they are exactly the approaches that got us into trouble, and are likely to fare no better in producing better outcomes in this instance. Our problem is not with debt itself (much of which represents productive past investment), it is with imbalances, misallocated resources, distorted financial markets, bad debt held on the books as if it is good, and the quiet reliance on the public to bail out losses that should be borne by the private sector.

I strongly believe that part of the gap between total credit market debt and cumulative gross investment is literally thin air, in the sense that assets are being held on the books of banks and other financials that are not worth the sharpened pencils that are needed to perpetuate the illusion of value. On that subject, we've received a number of notes from observant shareholders pointing out that the Chief Financial Officer of Wells Fargo has inexplicably resigned. I observed several quarters ago that we could observe a wave of fresh risk aversion "at the point where the first bank CFO resigns out of refusal to sharpen his pencil any further," but as I've noted below, the FASB appears intent on preserving the existing set of accounting rules allowing financial institutions to value their assets with "substantial discretion," with no necessary link to market values. So it remains unclear what the true state of the banking system is, and the extent to which further bailouts will ultimately become necessary down the road. It will be important to keep watch on how this develops.

In any event, the bottom line is that real economic growth is best supported by the allocation of savings to productive investment. Rapid expansion of credit market debt, relative to real savings and investment activity, is indicative of a credit bubble - what Ludwig von Mises termed "false prosperity." Absent the incentive to save, and the availability of productive investment opportunities, the Fed's monetary interventions serve to do little but misallocate resources and capital.

An Open Letter to the Financial Accounting Standards Board

To: Financial Accounting Standards Board
From: John P. Hussman, Ph.D.

Dear FASB Board members,

As one of the few economists that urgently warned three years ago about the oncoming financial crisis (see Minding the Hinges on Pandora's Box ), I am not simply disappointed, but stunned that the FASB has indicated a willingness to move back to amortized cost in the accounting of bank loans, in a banking system that is well known to have trillions of dollars in mortgage loans with underwater collateral, as well as millions of delinquent but unforeclosed loans. Rather than opting for procedures that would require adequate reflection of impairment or even quasi-market valuation such as 3-year averaging, the FASB appears intent on laying a lovely turf lawn over a toxic waste dump.

The FASB is a standards board. Standards. You are not running a popularity contest. Leslie Siedman cited “strong signals from the board's constituents” as the basis for the accounting decision, but precisely who are your constituents? Are they the bank representatives and lobbyists who undoubtedly stuffed your in-boxes with objections, or are they the general public – who rely on full, fair and accurate disclosure – but who scarcely can be expected to address the FASB on detailed accounting rules and therefore must trust you to act on their behalf?

Does any among you believe that the mortgage loans on bank balance sheets are actually worth amortized cost, when many of those loans are presently considered “current” only because they have been modified to tack delinquent payments onto the back end of the payment stream? You know better.

It matters urgently which “constituents” you presume to represent. Consider today's text from the Wall Street Journal:

“The Financial Accounting Standards Board preliminary vote would allow banks to continue valuing many of their loans at amortized cost, an adjusted version of their original cost, as they do now. That backtracks on an FASB proposal last May to expand fair value to bank loans. The reversal is a victory for the banking industry, which says it would have hurt lending and unfairly reduce banks' book value. Supporters of the FASB fair-value proposal say it would have improved transparency and unmasked potential weakness at banks. The FASB indicated the overwhelmingly negative reaction to its proposal from companies and investors played a large role in prompting the board to change its mind. The board received more than 2,800 comment letters on its fair-value proposal, most of them opposed to the move.”

That text might as well now read as follows:

“The Financial Accounting Standards Board preliminary vote would allow Bernard Madoff to continue valuing many of his funds based on the value of the original investments made by investors, before they were embezzled, as Madoff does now. That backtracks on an FASB proposal last May to expand fair value to pyramid schemes. The reversal is a victory for the Ponzi industry, which says it would have hurt lending and unfairly reduce Ponzi schemes' book value. Supporters of the FASB fair-value proposal say it would have improved transparency and unmasked potential weakness in Ponzi schemes. The FASB indicated the overwhelmingly negative reaction to its proposal from Ponzi schemes and investors hoping to trade the schemes higher played a large role in prompting the board to change its mind. The board received more than 2,800 comment letters on its fair-value proposal, most of them opposed to the move. Ordinary and less sophisticated investors [not to mention the public who will eventually be called on to clean up the mess], trusting the FASB and the SEC to get it right, didn't realize that they had to write a letter, and are therefore [expletive deleted] out of luck.”

Congratulations. You've turned the U.S. banking system into the Love Canal.

I urge the Board to think very carefully about precisely who its constituents are, and to maintain the words “standards,” “complete,” “fair,” and “accurate” in the forefront of its deliberations.

Sincerely,

John P. Hussman, Ph.D.
Hussman Investment Trust

GDP Disappoints, But Stocks Skyrocket Anyway

"Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.8 percent in the fourth quarter of 2010, (that is, from the third quarter to the fourth quarter), according to the "second" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.6 percent."

GDP was revised downward from 3.3% previously.

News is now irrelevant. Information is now irrelevant. We have printed prosperity now!

Stocks Recover from Fierce Overnight Sell-Off

Unemployment Improves, Capital Goods Doesn't

from Zero Hedge:

"...while the employment picture was better than expected, the capital goods data was a total disaster: January US Capital Goods orders non-defense ex. aircraft plunged by -6.9% M/M on expectation of just a -1.0% drop (Prev. 1.4% Rev. 4.3%). And just excluding Transportation, durable goods collapsed by 3.6% on expectations of a 0.5% increase. Time for those downward GDP revisions."

Recovery At Risk

from Reuters:

LONDON, Feb 23 (Reuters) - The global economic outlook is beginning to look grim as inflationary pressures accelerate and growth headwinds mount.
Effective oil prices (including refiners' margins for products such as gasoline and distillate) have risen well above $100 per barrel in response to strong demand from emerging economies and escalating unrest in the Middle East.

Crude Oil Spikes Above $103

This could spell another leg down for the U.S. economy.

Stocks Plunge Into the Abyss

Crude oil spiked above $103, and the stock market quickly collapsed.

Crude Oil: One Hair from $100

Freefall

Gold Too!

Dollar Beaten Up

Crude Oil Reaches $98

Where's the Plunge Protection?

Crushing Collapse

Stock futures have plunged in the past two hours. I don't know why.

Rally Turns to Rout

Corn Limit Down in Commodity Rout

It's about time! Just learned that we only have a 4% grain reserve.

David Rosenberg Throws Cold Water On An Overheated Market

From Gluskin Sheff's David Rosenberg
Fiscal Contraction Is Coming.... This Is A Key Theme
What exactly are the reasons to be bearish on the bond market? Oh yes, fiscal deficits!
Well, if you haven’t yet heard, major budgetary restraint is coming our way in the second half of the year, and so we would recommend that you enjoy whatever fiscal and monetary juice there is left in the blender. There isn’t much that is  for sure. The weekend newspapers were filled with reports of how the conservative wing of the Republican party have banded together to ensure that spending cuts will be in the offing — see In House, Republicans Close to Approving Record Cuts on page A13 of the Saturday NYT. The state and local governments are already putting their restraint into gear — see Wisconsin Leads Way as Workers Fight State Cuts on the front page of said NYT; and Wisconsin Democrats Keep On the Move on  page A3 of the weekend WSJ. First it was Christie’s New Jersey that was a role model in terms of embarking on true fiscal structural reforms. The baton was then passed to Mitch Daniels in Indiana. Now it is Scott Walker in Wisconsin who is the new poster boy for fiscal reforms and necessary restructuring.
What is happening at the lower government level definitely has a grassroots Mike Harris ring to it, and for those that do not know who Mike Harris is go ahead and google him and the ‘Common Sense Revolution’ that gripped Ontario in the 1990s. Yes, it can be done. And shared sacrifice by the civil servant  community, not widespread defaults at the state and municipal level, is going to be the solution — either accept higher contribution rates to your pension, higher payments for your health care, and wage cuts — or lose your job. Sounds like the deals that ultimately got struck across the lean and mean private sector in recent times from the auto sector to the airlines (wasn’t GM at one point nothing more than a health insurance provider?). To think that the President can stick his nose into local government budgetary affairs and accuse Wisconsin of an “assault” on unions (then again, didn’t he once accuse a police officer of being a racist?) at a time when he plans to actually EXPAND the federal government deficit this year to $1.7 trillion is truly remarkable.
In any event, the process towards fiscal integrity will continue unabated and we highly recommend added readings on the topic — see Battle Fuels Wider War Over Labor, Spending and Public-Pension Fight Surfaces in California. The free lunch is over and with it the expectation that there will be sustained growth in domestic spending. Yes, the corporate sector is cash rich but well over half of the so-called $2 trillion of dry powder sitting on U.S. company cash balances are locked in deposits overseas and will not be brought home due to American tax policy (see Why Investors Can’t Get More Cash Out of U.S. Companies on page B1 of the weekend WSJ). And yes, it is a big world out there and most of U.S. sales growth has come from the once-hot overseas economy, but between the massive fiscal restraint in much of Europe and the anti-inflation monetary tightening in the emerging market universe, that gravy train of strengthening domestic demand abroad will be sputtering before long.
What a market trained to focus on this quarter’s earnings reports cannot see right now are the inherently variable lags between policy shifts and the ensuing impact on real economic activity and profits. The investors that chose to focus on the rear and side view mirrors in 2000 and again in 2007, as opposed to looking through the front window, were the ones that emerged as the big losers. The folks that got greedy at the peak and did not lock in that last 13% gain in the S&P 500 in the year to the ultimate 1,565 peak in the fall of 2007, saw those gains totally vanish in front of their eyes in barely more than three months. Easy come, easy go.
Headlines that read On A Roll: Equity Bulls Have Taken Over on page 15 of the FT are sure to lure the last vestiges of investors who have waited, frustratingly, on the sidelines into the market at exactly the wrong time. When strategists concoct reasons why investors should ignore cyclically-adjusted P/E ratios, it conjures up the memory of why it made perfect sense to avoid classic valuation metrics back in 1999 and 2000 and focus on EBITDA and eyeballs per millisecond. Ahhhh ... the pain of “missing out” on a speculative 100% rally has replaced the pain of being involved in a 60% downslide just a short two years ago. Memories are short. That is what we have learned in this gigantic rollercoaster ride. The Fed’s policies, the ones that Bernanke defends, nurtured the post-LTCM rally that took the S&P 500 from 959 on October 8, 1998 (after the Fed cut rates intra-day to save the day) to 1,520 by September 1, 2000. It was a virtual non-stop 60% rally. But liquidity induced rallies only have a certain shelf life. The stimulus did end. The lags kicked in, and by July 2, 2002, the S&P 500 was down to 948 so all the speculative rally was undone and then by October 9th of that year, the S&P 500 had slid all the way down to 776.
The Fed then dug deeper into its bag of tricks and massively re-stimulated until the stock market carved out a bottom and embarked on a 100% rally from that low of 776 to 1,565 on October 9, 2007. The writing had been on the wall for so long but like today, bonds were the enemy and the good times were destined to last forever, didn’t you know. The fear that was rampant on October 9, 2002 had morphed into greed on that same day in 2007. Instead, we had another recession nobody saw coming, and all sorts of reasons to dismiss the overvalued and overextended nature of the market. Those who refused to drink from the Fed’s spiked punchbowl were viewed with the same derision they faced when they were considered old-economy dinosaurs back in 1999-2000. In contrast to rallies based on sound economic fundamentals as we had during the secular bull markets in the past, liquidity-infused rallies are truly dangerous animals and need to be handled with great care and a dose of trepidation because the thing about liquidity is that it is your best friend one day, and a coward the next. So it was with the downdraft from the 1,565 highs in October 2007 to the 676 lows in March of 2009.
Now, after an unprecedented experience of fiscal and monetary ease, ranging from bailouts, to TARP assistance, to guarantees, to government buying of shares, to accounting rule changes, to verbal market manipulation, to massive expansions of the central bank balance sheet, and record levels of deficits and debts, and not just in the U.S.A. but globally, the S&P 500 has soared from 676 to 1,343. It took five years to double in the last cycle; two years this time  around.
What to do, what to do, what to do? If jumping in after a “double” in the last liquidity cycle proved to be the wrong thing to do, what makes anyone think it won’t be the same this time around?
The S&P 500 actually followed the Fed balance sheet more closely last year than anything else ? including the flow of corporate earnings reports. And if the Fed does not embark on QE3 in June, there could be a problem lurking ? especially since the other spigot, fiscal policy, moves from stimulus to restraint in the second half of the year. It would have been nice to have been 100% in equities since the March lows, especially the lowest quality, most expensive and deepest cyclical stocks. Ah, the benefit of hindsight, but one could have said the same in the fall of 2007 ? the ignominy of sitting out a double!! But to throw in the towel at this stage could prove fatal to your wealth and we don’t recommend an overweight position right now. Remain patient. Understand that once things turn, and eventually they do, there will not be anyone to really support the market since practically all fund managers are fully invested and have as much cash on hand as they did at the October 2007 highs.
Our advice is to sit tight, get paid an economic rent, and then opportunistically capitalize on the eventual corrections that are a normal part of any market cycle, and tend to be more pernicious after rallies that were built on sticks and straws of government liquidity than the bricks that are generally laid by organic economic growth and an expanding private sector capital stock.
Sadly, the past recession did not resolve the glaring imbalances permeating the U.S. economy. By expanding their balance sheets, the Federal government and Federal Reserve have really only managed to create an illusion of prosperity. Maybe this is what they have to do ? buy as much time as possible. Kick the can down the road just far enough in the hope that something ignites the economy to the point that growth can be sustained without reliance on government-administered steroids. Printing money does not create wealth. It actually risks eroding real purchasing power. And governments may be able to redistribute income but in no way can create it ? government’s tax, spend and borrow. The national debt is now $1.41 trillion.
The United States is a 236-year old country, and almost 40% of the entire public sector debt has been built up by the current Administration in barely more than two years. The United States has a monetary base of $2.06 trillion, and nearly 60% of that has been created since Helicopter Ben took over the cockpit in early 2006. A 236 year-old country, and well over half of the stock of money has been created in just the past half-decade. Remarkable. Maybe the real question we should be asking is why the stock market has only managed to double from the lows with all this massive intervention?
Well, as Dandy Don used to bellow out on Monday evening blowouts back in the 70s and 80s, “turn out the lights, the party’s over. They say that all good things must end ...”
Indeed, while every economist has raised the 2011 GDP forecast because of the fiscal stimulus initiated late last year, nobody has adjusted their projections for the looming fiscal drag. Not only that, but it is becoming crystal clear that the Treasury debt ceiling is going to emerge as a potentially destabilizing issue very soon ? see U.S. Faces Deadlock Over Budget on page 3 of the weekend FT as well as Deficit War May Lead to Gov’t Shutdown on the front page of Monday’s Investor’s Business Daily.
As for monetary policy, inflation is simply going to be too high for the Fed to be able to embark on QE3 as early as June, which is when QE2 expires and this is too bad for the bulls because it is very evident that the liquidity rush had a much bigger impact on equity valuation since the end of last summer than either the economy or earnings did ? see Betting on Ben: Central Banks Have Been Supporting Share Prices in the always excellent Buttonwood column in the Economist (page 83). Caveat emptor. At the same time, QE2 has only been a success in terms of generating a speculative and liquidity-induced rally in equities, it has not helped redress the dismal job market backdrop ? the decline in the labour force participation rate did a far better job in pulling the unemployment rate down than Fed policy ever did.
The Fed’s policies, by triggering a pro-risk investment landscape, led to money being pulled out of the bond market to such an extent that mortgage rates have skyrocketed back above 5% and thereby further impaired the housing market. At the same time, the Fed’s policies have at least played a partial role in stimulating this most recent up-leg in commodity markets, and this in turn has an impact on real consumer spending since the surge in food and fuel prices in particular will exert a negative impact on discretionary expenditures. All the more so after the fourth quarter drop in the savings rate, which looked to be one part wealth effect and one part pent-up demand (the recovery is six quarters old and Q4 was the only one that could remotely be called decent as far as consumer expenditure growth is concerned).
But from the spreading political turmoil in the Middle East to real spending power here at home, there is no question that the global food crisis is a real game-changer as far as the macro and market forecast is concerned. Current corn stockpiles now represent 4% of annual consumption, according to the WSJ, perilously below the 15-year average of 13.5%. This is a shortfall equivalent to around 10 million acres. Look at the ingredients of any packaged food and you will see something related to either corn, or soybean, where there is an estimated four million acre shortfall. In turn, this is one reason ? inflation ? as to why the emerging equity markets have so woefully underperformed so far this year ? down 3.5% versus the 5% advance in developed markets. Inflation in China is around 5% (and likely under-reported) and 8% in India. And when you go back to August 2010, when QE2 was announced, U.S. core inflation was 1.1% and headline was 0.1%; by June of this year, we will probably be looking at 1.5% on the core and as high as 3% on headline inflation. That combined with the reality that the S&P 500 is 300 points higher now than it was then would certainly suggest that the case for extension of the Fed’s QE program will not be there, at least not by the time QE2 runs its course. So this is what we would be looking for in terms of chronology (it may be too late to sell in May this year).

• March: Irish elections. Default back on the table. Euro weakens. Flows into front end of the Treasury curve.
• April: Debt ceiling is hit. Political gridlock in vogue. Market volatility ensues. Gold and silver firm.
• June: End of QE2. Stock market wobbles like it did last year under similar conditions. Bonds and the U.S. dollar rally. High-beta stocks slip.
• July: Start of fiscal year for state and local governments. Big retrenchment begins and takes a bite out of economic activity.
• October: End of fiscal year for the federal government. Fiscal restraint replaces three years of radical fiscal expansion. Big rally in bonds. U.S. dollar should firm up too.
• December: The payroll tax cut and the bonus depreciation allowance both expire, creating a huge air pocket for first quarter growth in 2011. Talk of recession accelerates. Bull flattener in Treasuries likely to ensue. Equities will still be in corrective mode as double-dip risks re-enter the market mindset.

And keep in mind, recessions and near-recessions do occur in election years: 1960, 1964, 1972, 1976, 1980, 1992, 2000, and 2008 are examples.
Besides the sluggish labour market environment, rising food and energy prices, which is one-quarter of the spending bucket, renewed deflation in residential real estate values and the sudden loss of fiscal and monetary policy support that is around the corner, another impediment to a sustained spending cycle in the U.S.A. is the very poor financial shape that the boomer population finds itself in after years of spending far above its means (which is one reason why it seems so incredulous to read Bernanke Defends U.S. Policies on page A6 of the weekend WSJ seeing as Fed policies over the years have increasingly been geared to fuelling excessive consumption via asset inflation).
Have a read of the sad but true article on the front page of the WSJ (weekend edition) titled Retiring Boomers Find 401(k) Plans Fall Short. The statistic in there was pretty scary but it does tell us that the savings rate will resume the upward trend that was temporarily broken last year. The median household headed by a person between the ages of 60 and 62 with a 401(k) account has put away less than one-quarter of what is needed to meet their standard-of-living needs in retirement. Yikes. Remember, there are 78 million boomers that are going to turn from being net borrowers and spenders towards net creditors and savers. This is definitely bullish for long-duration bonds, by the way, which is the most detested asset class on the planet right now, confirmed by the latest Merrill Lynch survey of global portfolio managers.

But Stocks Continue their Risk Rallies

Housing: From Bad to Worse

thanks to Zero Hedge:

As of December, so almost three months ago, the housing double dip was getting increasingly worse. This was confirmed by the latest Case Shiller data, according to which the 10- and 20-City Composites posted annual rates of decline of 1.2% and 2.4%, respectively. The 20 City Composite printed at 142.16, the lowest since June 2009 when it was 141.75. Luckily, NAR's now completely disgraced Larry Yun is nowhere to be found in this release, from which we quote: "Data through December 2010, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show that the U.S. National Home Price Index declined by 3.9% during the fourth quarter of 2010. The National Index is down 4.1% versus the fourth quarter of 2009, which is the lowest annual growth rate since the third quarter of 2009, when prices were falling at an 8.6% annual rate. As of December 2010, 18 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were down compared to December 2009." Bottom line: the chart says it all.

Those hoping for some soothing Kool Aid will not find it in the following quotes:

“We ended 2010 with a weak report. The National Index is down 4.1% from the fourth quarter of 2009 and 18 of 20 cities are down over the last 12 months. Both monthly Composites and the National Index are moving closer to their 2009 troughs. The National Index is within a percentage point of the low it set in the first quarter of 2009. Despite improvements in the overall economy, housing continues to drift lower and weaker.” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor's. “Unlike the 2006 to 2009 period when all cities saw prices move together, we see some differing stories around the country. California is doing better with gains from their low points in Los Angeles, San Diego and San Francisco. At the other end is the Sun Belt – Las Vegas, Miami, Phoenix and Tampa. All four made new lows in December. Also seeing renewed weakness are some cities that were among the last to reach their peaks including Atlanta, Charlotte,  Portland OR and Seattle, where news lows were also seen. Dallas, which peaked late, has so far stayed above its low marked in February 2009.”

“The 10- and 20-City Composite indices remain above their spring 2009 lows; however, 11 markets – Atlanta, Charlotte, Chicago, Detroit, Las Vegas, Miami, New York, Phoenix, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices peaked in 2006 and 2007. We have seen more markets hit new lows in each of the past three months.”

“Looking deeper into the monthly data, 19 MSAs and both Composites were down in December over November. The only one which wasn’t was Washington DC, up 0.3%. With December 2010 index levels of 99.73 and 99.48, respectively, Cleveland and Las Vegas have the dubious distinction of average home prices now below their January 2000 levels. Detroit was the only market that was in that group prior to December”

Full report.

Debt Exceeds Size of Entire U.S. Economy

from Washington Post:
The daunting tower of national, state and local debt in the United States will reach a level this year unmatched just after World War II and already exceeds the size of the entire economy, according to government estimates.
But any similarity between 1946 and now ends there. The U.S. debt levels tumbled in the years after World War II, but today they are still climbing and even deep cuts in spending won't completely change that for several years.
As President Obama and Republicans squabble over whose programs to cut and which taxes to raise, slow growth and a rising tide of interest payments - largely beyond their control - are making the job of fixing the budget much harder than in the past. Statehouses and governors face similar challenges.
After World War II, the federal debt - including debt purchased by the Social Security Trust Fund - hit nearly 122 percent of gross domestic product. State and municipal debt back then was minimal. By the time Dwight Eisenhower was elected president six years later, the federal government's debt had dipped to about three-fourths of GDP.
The key factor in the rapid drop in government debt, said Harvard University economist Kenneth Rogoff, was fast economic growth. Spurred by a young labor force, world-leading manufacturers, high personal savings rates, a pent-up demand for consumer goods after years of war and the Depression, and a bout of inflation, the economy grew 57 percent in six years. Thanks to sharp postwar cuts in defense outlays, federal government spending also tumbled for a couple of years.
But today the U.S. economy is in a polar opposite condition. The labor force is aging, U.S. manufacturing often lags behind Asian and European rivals, households are in hock up to their eyeballs, and consumer appetite for goods is tepid. In addition, inflation is tame and government spending locked into entitlement programs and debt service that will be hard or impossible to alter.
"We're not growing like we were after World War II, so the amount of debt you can bear and the trajectory are much worse," Rogoff said.
Moreover, today state and municipal governments are also facing fiscal woes - another difference between now and the postwar era. State and municipal governments from Sacramento to Madison to Harrisburg have racked up about $2.4 trillion in debt, or more than 15 percent of GDP.
Even if analysts leave aside the debt held by the Social Security Trust Fund, the total indebtedness of federal, state and local governments is running around 85 percent, vs. 108.7 percent in 1946.
"It's still very, very, very high," Rogoff said, "and there are a lot of things on the other side of the equation that are much worse." Moreover the debt held by Social Security, which is in surplus now, will have to be paid later as the ranks of senior citizens grow.
Robert D. Reischauer, president of the Urban Institute and former director of the nonpartisan Congressional Budget Office, said that the debt accumulated by 1946 "was for a very different purpose, which was to preserve freedom and democracy versus totalitarianism rather than to throw a huge party and put it on the credit card."
He said that state governments have also squandered much of their spending and failed to meet all their pension obligations.
Reischauer stressed that after World War II, consumers, many of whom had purchased savings bonds, and banks, which had been required to hold certain amounts of government debt, were in strong positions. Today's consumers and banks are strapped.
"We had large household savings, and we flourished," he said of the post-World War II era.
Inflation also reduced the value of World War II-era debts because the United States could pay them back with money that had less buying power. Inflation reached 14 percent in 1947. Many investors fear that inflation is looming now, too, and may be the only way to ease the debt burden. But with high unemployment and slow growth, so far there is little sign of it. On Thursday, the Labor Department said inflation was 1.2 percent during 2010.
Rogoff and Carmen M. Reinhart, a University of Maryland economics professor, have done research showing that once government debt surpasses 90 percent of GDP, average growth rates slide 4 percent. In emerging markets, the threshold is lower and the damage to growth greater.
Slower growth will only slow the erosion of the national debt.
State budget experts say that some governors have exaggerated their fiscal woes. Thanks to relatively low interest rates, states spend on average 4 percent of their budgets to make debt payments, said Joshua Zeitz, state and municipal finance analyst at a research firm, MF Global, and former senior policy adviser to former New Jersey governor John Corzine. (By some calculations, he said, the average is a still modest 5.5 percent.)
Zeitz said that many governors speak of "cuts" when they mean cuts from projected spending, assuming continued growth from inflation and other factors. Many states whose governors boast of making budget cuts could end up with higher levels of spending.
Wisconsin, where Gov. Scott Walker (R) has rocked the legislature with proposed limits on state employee unions, is one of those, Zeitz said. The state is on a two-year budget cycle. This year the governor has talked of a $137 million shortfall, though Zeitz said it was largely of Walker's own making through tax cuts and spending initiatives. In any case, that amount would equal 1 percent of the state budget. "A 1 percent shortfall does not constitute a crisis," Zeitz said.
Walker said the state faces a more than $3 billion deficit next year, but Zeitz said that includes assumptions about program growth and revenue.
Scott D. Pattison, executive director of the National Association of State Budget Officers, estimates that state government revenue will increase 5 percent this year. "The pie is expanding," he said.
But not fast enough for the government sector overall. According to Obama's fiscal 2012 budget proposal released Monday, the federal government's net interest payments (not including money owed the Social Security fund) will rise from 1.4 percent to 3.4 percent over the next decade.
Federal debt (not including debt held by the Social Security fund) fell to a post-World War II low of about 24 percent in 1974. After tax cuts and increased defense spending under President Ronald Reagan, it rose to about 49 percent in 1993, before President Bill Clinton's budget deal took effect. It then fell to 32.5 percent in 2000, but starting rising again when President George W. Bush took office. Tax cuts, war spending and recession costs have more than doubled that level since.
Recalling the post-World War II economy that helped ease government indebtedness, Reischauer said: "It wasn't that when you looked out the windshield of the federal car that you saw steep hills ahead as you do now. It's a very different kind of situation."

Crude Oil Too!

Wondrous Worry Sends Gold $20 Higher

Moodys Downgrades Japan's Debt

Moody's Investors Service has today changed the outlook on the Government of Japan's Aa2 rating to negative from stable.

But Stocks Are Only Modestly Lower

In these manipulated markets, stocks are only modestly lower. Thus, while inflation surges, Wall Street ignores the portents and buoys stocks despite global civil unrest. What better testament to the stock market bubble than this? Wall Street, awash in Fed-printed money, ignores the risk in global unrest, and keeps going higher week after week.

Oil, Gold Surge on Unrest

Crude Oil Up $3

Gold Up $15

Can it be? Stocks affected too? Not so much!

Rick Santelli: Budget Crises Are the Next 9/11

from Politico.com:

CNBC's Rick Santelli on Sunday compared the budget crises affecting state and federal balance sheets to a Sept. 11-type attack on the nation.

"If the country is ever attacked as it was on 9/11, we all respond with a sense of urgency," Santelli said in a roundtable discussion on NBC's "Meet the Press" about the Wisconsin labor protests. "What’s going on on balance sheets throughout the country is the same type of attack.”

There have been questions about the appropriateness of collective-bargaining agreements for public employees since the days of President Franklin D. Roosevelt, Santelli added, and states are realizing that pension and benefit costs need to be controlled.

"This is an issue that needs to be put out into the air," Santelli said. "Many other states ultimately — they might not have the same balance sheet as Wisconsin — but collective bargaining from the federal level ... these are big issues, and these costs need to be put under control."

In an unprecedented move, the number of investors fearing a catastrophic stock market crash is rising even with the stock market at 2 ½ year highs.

The unusual dislocation comes from two distinct reasons: a lack of trust in the U.S. financial markets following the so-called Flash Crash last May and the collapse of Lehman Brothers in 2007.

This means the Flash Crash Advisory Commission that met on Friday has a long way to go in restoring confidence to the point that will bring the individual investor back into a market still ruled by high frequency trading, exchange-traded funds and leveraged hedge funds.

The Yale School of Management since 1989 has asked wealthy individual investors monthly to give the “probability of a catastrophic stock market crash in the U.S. in the next six months.”

In the latest survey in December, almost 75 percent of respondents gave it at least a 10 percent chance of happening. That’s up from 68 percent who gave it a 10 percent probability last April, just before the events of May 6, 2010.

“Even though the market is firing on all cylinders, that fear of big losses still looms large for investors in a way that it didn’t prior to the last bear market,” wrote analysts from Bespoke Investment Group in a report citing the Yale data. “Clearly, the financial crisis and the collapse it caused has impacted investor psyche in a big way.”

In the past, fears of a stock market crash in the Yale survey rose as the market declined because investors lost confidence in the economy and companies as share prices declined, and expected a capitulatory end to a bear market. For example, in March 2009 close to 85 percent of investors gave a crash at least a 10 percent chance of occurring. That record high in distrust and low in confidence marked a 12-½ year low in the S&P 500.

(.SPX) Loading...       (%)

The benchmark has doubled since that low, but investors are not worrying about the prospects for individual stocks as much now now. Instead they are worrying about the still-unchanged system set up by Wall Street and regulators in which equities trade.

The Flash Crash Commission – containing members of the CFTC and SEC – made a series of recommendations for improving market structure Friday, including single stock circuit breakers, a more reliable audit trail on trades, and curbing the use of cancelled trades by high-frequency traders. They still don’t know what actually caused the nearly 1,000-point drop in the Dow Jones Industrial Average in a matter of minutes.

“Nine months after the Flash Crash and the committee is just about getting around to discussing a few things,” said Joe Saluzzi, co-founder of Themis Trading and market infrastructure expert. “This is just the way the high-frequency trading community and their supporters like it. Grind that reform train to a halt. After all, the market has come roaring back and if you didn't sell on May 6th, then nobody got hurt.”
For the agile professional investor, fear of another crash is not really a concern right now. Surveys show bullish sentiment high among the pros. Hedge funds have increased leverage again to pre-Lehman levels. Wall Street banks paid out large year-end bonuses and are about to start paying dividends again. This professional confidence has been reflected in a steady stock market climb since the summer that’s barely experienced a major 1-day drop, let alone crash.

“Though we find the current steady, upward grind in the market to be very unusual, it is important to realize that these low volatility conditions can persist,” said Andrew Barber of Waverly Advisors, in a note. “For instance, from January 2004 to July 2007, 90 day realized volatility in the S&P 500 traded in a range roughly bounded by 7 percent to 13 percent, averaging just above 10 percent for most of that period. Yes, this is 3 1/2 years of volatility roughly equivalent to what we are seeing now.”

Overall volume has been very light in the market though, as the individual investor put more money into bonds last year than stocks in spite of the gains. Strategists said this has been one of the longer bull markets (starting in March 2009) with barely any retail participation. Flows into equity mutual funds did turn positive in January and have continued this month however, according to ICI and TrimTabs.com. Yet the fear of a crash persists.

“Belief in a coming Flash Crash is Chicken Soup for the Underinvested Soul," said Josh Brown, money manager and author of The Reformed Broker blog. “They aren't so much expecting one as hoping for one - so they can rationalize buying into a market that's left them behind.”

Stocks Know No Bounds

And Wall Street ignores all the risks!

Silver Fireworks

Grains Rebound Higher After Short Correction

Like me, I think many covered their shorts today and bought again, moving the market sharply higher.

Natural Gas Resumes Downtrend Following Bearish EIA Report

It will be time to buy again soon.

Silver Shines

Fed Inflation Vs. Organic Inflation -- NOT the Same

You Want Inflation? Here's How To Get It   
Rising prices driven by speculation is not the same as organic inflation, and diverting national income to the banks will not create organic inflation.

The Federal Reserve's stated goal is to create modest inflation. Unfortunately they don't grasp the difference between speculative inflation and organic inflation. The Fed's official goals are to stabilize prices and maintain employment, and its de facto policy to achieve these lofty, high-minded goals is to divert huge sums of the national income to the insolvent banking sector.

The Fed also seeks to bail out the insolvent debt machine by generating some nice solid inflation, to boost the impaired assets held by banks. In other words, the Fed is specifically seeking to create asset inflation, which will eventually enable the banks to appear marginally solvent as their real estate and other assets rise in value.

Let's turn to the origins of the Fed inflation policy, as stated by Chairman Ben Bernanke in his various papers and speeches: deflation VS inflation: an Austrian Analysis:

In a paper from which he earned the sobriquet "Helicopter Ben," Chairman Bernanke provided a thought experiment to demonstrate that any deflation could be defeated: most economists would agree that a large enough helicopter drop [of newly created money] must raise the price level...at some point the public would attempt to convert its increased real wealth into goods and services, spending that would increase aggregate demand and prices.

In a speech a few years later, Bernanke detailed the policy mechanism by which the circulation of dollars might be increased at will: If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets. "We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

Here's the problem with Bernanke's "solution:" the assets he's goosed ever higher (stocks and bonds) are only held indirectly via pension funds for the bottom 80% of the populace. Only the top 10% of the citizenry own enough stocks and bonds directly to experience the "increased real wealth."

As a result, there's no follow-through of higher spending. Bernanke's policies have failed to generate higher spending for a number of fundamental reasons.

The distinction between housing assets and equity assets is absolutely critical, but it's completely lost on the Fed. We can see Bernanke's game plan in action in the most recent Fed Flow of Funds.

Housing equity has plummeted roughly $6 trillion from the bubble peak to Q3 2010 (and it has slipped further since): $22.6 trillion to $16.5 trillion.

Stocks and bonds, meanwhile, have gained $6 trillion--a nice symmetry. In Q1 2009, corporate equities ($5 T), mutual funds ($3.1 T) and pension fund reserves ($10.4 T) added up to $18.5 trillion. By Q3 2010, these had risen smartly to $24.4 trillion (corporate equities $7.8 T, mutual funds $4.4 T and pension fund reserves $12.2 T)

Housing is the primary household asset for roughly 2/3 of U.S. households, while stocks and bonds are the primary asset for only the top 5%. So what Bernanke has effectively overseen is a massive transfer of private wealth.

He's also accomplished a stupendous transfer of national income to the financial Elites in the banking sector by lowering interest rates to zero (ZIRP). Back in the low inflation 1960s, banks and savings and loans were required to pay 5.25% on all savings. Cash, in other words, generated substantial income for ordinary savers.

The idea with ZIRP is to loan the banks essentially free money, which they can lend out at between 5% and 12% (or higher), generating "free" profits. The Fed's plan is to sluice these gigantic profits to banks so they can recapitalize their insolvent balance sheets without any direct handouts. But ZIRP is nothing but an indirect transfer of wealth from the private sector (now completely deprived of any interest income) to the banks.

The Fed's policies allow for only two ways to access this newly created "increase in real wealth" for the top 10%: sell the assets or borrow money from the banks. If people cash out their stock gains, then that would automatically push stocks lower, bollixing the game plan. The Fed's intention is to "nudge" the populace into borrowing more money from the banks at nominally high rates of interest (anythijng above 0% is pure profit for the banks).

Unfortunately for the Fed, those with rising assets are no longer hankering for higher debt levels, and the bottom 80% are no longer qualified to borrow. So what we have is a speculative asset inflation which is spilling over into commodities as hot money borrowed for next to nothing seeks higher returns anywhere on the planet.

Contrast this with organic inflation, in which people with lots of free cash are chasing limited goods and services.

Inflation itself is a transfer of wealth. As noted in the paper linked above:

In short, the true crux of deflation is that it does not hide the redistribution going hand in hand with changes in the quantity of money. It entails visible misery for many people, to the benefit of equally visible winners. This starkly contrasts with inflation, which creates anonymous winners at the expense of anonymous losers.

Inflation is a secret rip-off and thus the perfect vehicle for the exploitation of a population through its (false) elites, whereas deflation means open redistribution through bankruptcy according to the law.

The reason that public sentiment has always been biased against monetary deflation can be found in the manner in which wealth transfer occurs under inflationary and deflationary environments. During an inflationary credit expansion, wealth is transferred from the public in general to the earliest recipients of the newly created credit money. In practice the earliest recipients are interest groups with the strongest political connections to the State and, in particular, the State institutions that control monetary policy (i.e., the Federal Reserve in the United States).

Importantly, the wealth transfer that takes place during an inflation is hidden and largely unrecognized by the majority of the population. The population is unaware that the supply of money is increasing and the attendant rise in prices, ostensibly beneficial to business, initially produces [a] general state of euphoria, a false sense of well-being, in which everybody seems to prosper.

Those who without inflation would have made high profits make still higher ones. Those who would have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom. There is a general excess of demand over supply--all is saleable and everybody can continue what he had been doing.


And here precisely lies the answer to why the State prefers a policy of controlled inflation. Only in an inflationary environment can State largesse be conferred to the politically well-connected without raising public ire. The widespread and visible transfers of property through bankruptcy that must take place during a deflation are often politically destabilizing and thus highly unappealing to any regime. A sense of injustice grows within the population as banks are saved from the folly of their misguided investments with taxpayer-funded bailouts, while debtors with no political clout have property seized in bankruptcy.

Here is where we are in a nutshell. The general populace has seen its income decline as the Fed's ZIRP policy has channeled their interest income directly into the banks, and as their wages stagnate.

Yet thanks to the speculative inflation engineered by the Fed, prices are rising. In an organic inflation, wages and interest income would both be rising along with prices. So the direct result of the Fed's policies is higher costs and the transfer of national income to the banks.

The average household has seen its income and its asset base (housing) stagnate or decline. Meanwhile, the equities market, which directly "increases real wealth" in only the top 10%, has risen over 80% from the Q1 2009 low.

If the bottom 80% are seeing income and assets stagnate or decline, how can you possibly get organic inflation? Answer: you can't. And speculative inflation only benefits the top financial players, not the general populace.

If we combine this chart and the Fed Flow of Funds data, we find that mortgages total $10.1 trillion and other consumer debt is about $3 trillion.


You want to create organic inflation, driven by consumers with plenty of cash chasing goods and services? Here's how:

1. Reinstate the policy of paying 5.25% on all savings, effectively transferring wealth back from banks to citizens. If the banks can't manage to do so and remain solvent, then close them down and liquidiate their assets and liabilities. Others will rise to take their places.

2. Print $5 trillion in cash, not credit, and liquidate all consumer debt and a couple trillion in mortgage debt for those who are not hopelessly underwater.

3. Aggressively cram down underwater mortgages onto the banks, forcing them to liquidate all their bad debt. Yes, this will reveal them as insolvent, but the goal here is not to save the financial Elites' impaired assets, it's to reset the housing market by clearing off all the impaired debt in the system.

By resetting the consumer balance sheet and paying interest, then you would be putting cash into households which could be spent in the real economy.

Is this a wise or prudent policy? I don't know. The goal here was not to assess that question, it was simply to follow up on the goal of creating inflation. If you want organic inflation, you have to divert the national income from the banks to the citizenry, and you have to reset the housing market.

The Fed's policies cannot create organic inflation, because all the Fed is doing is transferring wealth to the nation's Elites. Their spending on luxuries and fine dining are not broadbased enough to generate organic inflation in the entire economy.

Borrowing money does not drive organic inflation: higher incomes and free cash drive organic inflation. If you want inflation, then you have to increase the incomes and assets of 60% of the households, not just the top sliver who own most of the financial assets.

Housing Starts Increased, But Mortgage Applications Plunged

And that means an ever more overbuilt housing market. Not a good sign!

Inflation 66% Higher Than Fed Reports

from Daily Finance:

By DAN BURROWS Posted 6:30 AM 02/16/11 Economy, Investing

Comments Print Text Size A A A Email This

Global food prices are at an all-time high, U.S. gasoline prices are at the costliest level ever for this time of the year and yet inflation, in the words of Federal Reserve Chairman Ben Bernanke, remains "quite low."

By official reckoning, that's certainly the case. On Thursday we'll get the latest monthly inflation figures in the form of the consumer price index, which, to the Fed chief's chagrin, is running too close to disinflationary levels. Economists, on average, expect January prices to increase at just a 0.3% rate. So-called core inflation, which excludes volatile food and energy prices, is forecast to rise just 0.1%.

As Bernanke testified before Congress last week, economists exclude food and energy prices because that core inflation rate "can be a better predictor of where overall inflation is headed." By that measure, inflation was only 0.7% in 2010, compared with around 2.5% in 2007, the year before the recession began, the Fed chief explained.

Too bad those numbers don't jibe with with most folks' experience at the gas pump or checkout counter. As economist Ed Yardeni, president of Yardeni Research, told clients Tuesday: "I share the growing concern among the Fed's critics that the official measures of consumer price inflation may be understating actual inflation and that excluding food and energy from these measures is OK as long as you don't eat or drive."



Alternative measures for inflation show a far more alarming picture of price increases than the official data suggest. One of the more intriguing approaches is The Billion Prices Project at the Massachusetts Institute of Technology, which collects daily price changes on about 5 million items sold by approximately 300 online retailers in more than 70 countries.

For U.S. price data, MIT tracks 550,000 products from 53 retailers. By this measure, annual inflation is currently running at a rate of 2.5% -- or 66% greater than the official CPI figure. See the chart above.

Core inflation may have run at just 0.7% in 2010, as Bernanke says, which is the lowest reading on record gong back to 1960. Even if you add back in those pesky food and energy prices, the number rises to 1.2% -- still no big deal. But by the Billion Prices Project's reading, inflation in 2010 more than doubled to 2.5%. "The Billion Prices Project @ MIT is finding plenty of evidence that consumer prices are rising faster than the official price data," Yardeni notes.

Whatever the latest data show Thursday, there's a big difference between inflation as a guide for monetary policy and its real-world impact on conusmers' pocketbooks.

PPI Up .8%, Housing Starts Rises

from Zero Hedge:

The PPI including food and energy came at 0.8%, in line with expectations, and a decline from the previous 1.1%. Ex food and energy, Producer Prices jumped from 0.2% to 0.5%, and over 100% higher than expectations of 0.2%. Somehow, food PPI increased by just 0.3%, the lowest since August, and once again making one wonder which Department of Truth is more unbelievable: ours or the Chinese. From the release: The Producer Price Index for finished goods rose 0.8 percent in January, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. This advance followed increases of 0.9 percent in December and 0.7 percent in November and marks the seventh straight rise in finished goods prices. At the earlier stages of processing, prices received by manufacturers of intermediate goods moved up 1.1 percent, and the crude goods index rose 3.3 percent. On an unadjusted basis, prices for finished goods advanced 3.6 percent for the 12 months ended January 2011.... The index for finished consumer foods moved up 0.3 percent in January, the fifth consecutive monthly increase. A 13.7-percent advance in prices for fresh and dry vegetables was the main factor in the January rise in the finished consumer foods index...In January, the index for intermediate foods and feeds moved up 0.4 percent for the second consecutive month. A 2.7-percent rise in beef and veal prices accounted for about forty percent of the January increase in the intermediate foods index.

Deficit As Proportion of Economy Hits Post-War Record

from MyWay:

WASHINGTON (AP) - Not since World War II has the federal budget deficit made up such a big chunk of the U.S. economy. And within two or three years, economists fear the result could be sharply higher interest rates that would slow economic growth.
The budget plan President Barack Obama sent Congress on Monday foresees a record deficit of $1.65 trillion this year. That would be just under 11 percent of the $14 trillion economy - the largest proportion since 1945, when wartime spending swelled the deficit to 21.5 percent of U.S. gross domestic product.
The danger is that a persistently large gap in the budget could threaten the economy. Investors would see lending their money to the U.S. as riskier. So they'd demand higher returns to do it. Or they'd simply put their cash elsewhere. Interest rates on mortgages and other debt would rise as a result.
And if borrowing turned more expensive, people and businesses might scale back their spending. That would weaken an economy still struggling to lower unemployment, revive real estate prices and restore corporate and consumer confidence.
So far, it hasn't happened. It's still cheap for the government to borrow money and finance deficits. But economists fear the domino effect if all that changes.
"The moment when markets react negatively to our budget deficit cannot be known in advance, but we are absolutely in the danger zone," says Marvin Goodfriend, an economics professor at Carnegie Mellon University's Tepper School of Business.
Higher interest rates would also raise interest payments on the federal debt. It would be costlier for the government to finance its operations. The interest payments themselves could then make the deficit increase, creating a vicious cycle.
Under the projections in Obama's budget, the deficit as a share of the overall economy would narrow from 10.9 percent this year to 7 percent next year and eventually to 2.9 percent by the 2018 fiscal year.
But after that, in the remaining years of this decade, the deficit would widen slightly as a percentage of the economy. It would average about 3.1 percent because of escalating costs for programs like Social Security and Medicare as baby boomers age and receive benefits.
Economists generally say cutting the deficit to about 3 percent or less of the economy would be healthy. Deficits at that level are considered "sustainable" - meaning they could be easily financed and wouldn't make investors nervous about the government's finances.
Most economists don't think the deficit should be cut deeply now. They say the economy remains so fragile - unemployment is at 9 percent - that it needs big government spending to invigorate growth.
In this camp is Federal Reserve Chairman Ben Bernanke. He's argued that now isn't the time to slash government spending or raise taxes. Instead, Bernanke has urged Congress and the White House to preserve federal stimulus - including tax cuts - in the short run but draft a plan to reduce the deficit over the long run.
A presidential commission last year made recommendations that Bernanke and other economists say could help curb the deficit over the long term. Its suggestions included raising the Social Security retirement age and reducing future increases in benefits. It also proposed increasing the gasoline tax and eliminating or scaling back tax breaks, like the mortgage interest deduction claimed by many Americans.
Obama embraced none of these proposals in his budget. But his plan is designed to cut $1.1 trillion from the deficit over the next decade, two-thirds of it from spending cuts. The rest would come from tax increases, such as limiting the deductions for high-income taxpayers.
In Bernanke's view, a long-term plan to reduce future deficits would mean lower long-term interest rates and increased consumer and business confidence.
For months, though, longer-term rates have been creeping up, driven by prospects of stronger growth and concerns about higher inflation. The yield on the 10-year Treasury note is now 3.61 percent. That's up sharply from 2.48 percent in early November.
That increase is making other loans, including mortgages, more expensive. The average rate for a 30-year fixed mortgage just rose above 5 percent for the first time since April.
Rates are still extremely low by historical standards. In 1983, during Ronald Reagan's first presidential term, the deficit soared to $208 billion, about 6 percent of the economy at the time. The rate on the 10-year note topped 10 percent. And getting a 30-year mortgage meant paying 13 percent.
Economists say that if investors trust that Congress and the White House will curb budget deficits over the long haul, interest rates could stabilize - even if deficits exceed $1 trillion over the next year or two. But if investors lose confidence that Washington policymakers can curb the deficits, rates could rise sharply.
"It's all about perception," says Lou Crandall, chief economist at Wrightson ICAP, a research firm.
So far, China, the biggest buyer of U.S. debt, and other countries have maintained their appetites for Treasurys. Foreign demand for Treasury debt has helped keep U.S. interest rates historically low.
The reason is that the United States is still considered a haven for many foreign investors. That point was underscored by Europe's debt crisis last year, when money poured into dollar-denominated Treasurys.
If the United States had to finance its debt through U.S. investors alone, the government, along with American companies and consumers, would have to pay higher rates.
Last year's budget deficit totaled $1.3 trillion. That was just under 9 percent of U.S. economic activity. The first time the deficit topped $1 trillion was in 2009.
The growth of U.S. budget deficits has reflected the costs of the wars in Iraq and Afghanistan, the continuation of broad tax cuts, the worst recession since the 1930s and a surge in spending on Social Security, Medicare and the military. The recession prompted higher government spending to stimulate the economy and cushion the effects of the downturn. It also reduced tax revenue.
The Organization for Economic Cooperation and Development estimates that the United States' deficit as a share of the U.S. economy will be smaller - around 8.8 percent- than the president's budget estimates.
Still, that would be a higher figure than for other major industrialized countries. The OECD projects, for example, that Britain's deficit this year will be about 8.1 percent of its economy. Germany's deficit is expected to make up 2.9 percent of its economy, Japan's 7.5 percent.
"So far, investors haven't been bothered by large U.S. budget deficits," says Jim O'Sullivan, economist at MF Global, an investment firm. "The fear is that could suddenly change. It's not clear whether investors will remain patient once the U.S. recovery is on track."

Unctuous Obama!

from WSJ:
WASHINGTON—The White House projected Monday that the federal deficit would spike to $1.65 trillion in the current fiscal year, the largest dollar amount ever, adding pressure on Democrats and Republicans to tackle growing levels of debt.
The projected deficit for 2011 is fueled in part by a tax-cut extension that President Barack Obama and Republican lawmakers brokered in December, two senior administration officials said. It would equal 10.9% of gross domestic product, the largest deficit as a share of the economy since World War II.
The new estimate is part of Mr. Obama's proposed budget for fiscal year 2012, which becomes public Monday morning.
Mr. Obama is proposing $3.73 trillion in government spending in the next fiscal year, part of a plan that includes budget cuts and tax increases that administration officials believe will sharply bring down the federal deficit over 10 years.

from Washington Examiner:
President Obama projects that the gross federal debt will top $15 trillion this year, officially equalling the size of the entire U.S. economy, and will jump to nearly $21 trillion in five years’ time.
Amid the other staggering numbers in the budget Mr. Obama sent to Congress on Monday, the debt stands out — both because Congress will need to vote to raise the debt limit later this year, and because the numbers are so large.
Mr. Obama‘s budget said 2011 will see the biggest one-year jump in debt in history, or nearly $2 trillion in a single year. And the administration says it will reach $15.476 trillion by Sept. 30, the end of the fiscal year, to reach 102.6 percent of gross domestic product (GDP) — the first time since World War II that dubious figure has been reached.
In one often-cited study, two economists have argued that when gross debt passes 90 percent it hinders overall economic growth.
The president’s budget said debt as a percentage of GDP will top out at 106 percent in 2013, but only if the economy booms.
“I still don’t see a sense of urgency from the president about the massive federal debt,” said Sen. Lamar Alexander, Tennessee Republican. “His budget calls for too much government borrowing – even though the debt is already at a level that makes it harder to create private-sector jobs.”  
Speaking on MSNBC on Monday, Jacob “Jack” Lew, the White House budget director, said their long-term plan to lower deficits will stabilize the debt.
“When we came into office, when President Obama took office, the deficit was climbing to over 10 percent of the economy. We have a plan that would bring it down to 3 percent,” he said. “That is the most rapid reduction in the deficit in history. It is what we have to do to be able to say we’re paying our bills and we’re not adding to the debt.”
The administration said debt as a percentage of GDP will stabilize at about 105 percent in the middle of this decade, though those calculations assume economic growth levels significantly above projections of the non-partisan Congressional Budget Office.
The government measures debt several ways. Debt held by the public includes the money borrowed from Social Security’s trust fund.

Geithner Admits Interest Costs to Surge

from Bloomberg:
Barack Obama may lose the advantage of low borrowing costs as the U.S. Treasury Department says what it pays to service the national debt is poised to triple amid record budget deficits.
Interest expense will rise to 3.1 percent of gross domestic product by 2016, from 1.3 percent in 2010 with the government forecast to run cumulative deficits of more than $4 trillion through the end of 2015, according to page 23 of a 24-page presentation made to a 13-member committee of bond dealers and investors that meet quarterly with Treasury officials.
While some of the lowest borrowing costs on record have helped the economy recover from its worst financial crisis since the Great Depression, bond yields are now rising as growth resumes. Net interest expense will triple to an all-time high of $554 billion in 2015 from $185 billion in 2010, according to the Obama administration’s adjusted 2011 budget.
“It’s a slow train wreck coming and we all know it’s going to happen,” said Bret Barker, an interest-rate analyst at Los Angeles-based TCW Group Inc., which manages about $115 billion in assets. “It’s just a question of whether we want to deal with it. There are huge structural changes that have to go on with this economy.”
The amount of marketable U.S. government debt outstanding has risen to $8.96 trillion from $5.8 trillion at the end of 2008, according to the Treasury Department. Debt-service costs will climb to 82 percent of the $757 billion shortfall projected for 2016 from about 12 percent in last year’s deficit, according to the budget projections.

Budget Proposal

That compares with 69 percent for Portugal, whose bonds have plummeted on speculation it may need to be bailed out by the European Union and International Monetary Fund.
Forecasts of higher interest expenses raises the pressure on Obama to plan for trimming the deficit. The President, who has called for a five-year freeze on discretionary spending other than national security, is scheduled to release his proposed fiscal 2012 budget today as his administration and Congress negotiate boosting the $14.3 trillion debt ceiling.
“If government debt and deficits were actually to grow at the pace envisioned, the economic and financial effects would be severe,” Federal Reserve Chairman Ben S. Bernanke told the House Budget Committee Feb. 9. “Sustained high rates of government borrowing would both drain funds away from private investment and increase our debt to foreigners, with adverse long-run effects on U.S. output, incomes, and standards of living.”

Yield Forecasts

Treasuries lost 2.67 percent last quarter, even after reinvested interest, and are down 1.54 percent this year, Bank of America Merrill Lynch index data show. Yields rose last week to an average of 2.19 percent for all maturities from 2010’s low of 1.30 percent on Nov. 4.
The yield on benchmark 10-year Treasury note will climb to 4.25 by the end of the second quarter of 2012, from 3.63 percent last week, according to the median estimate of 51 economists and strategists surveyed by Bloomberg News. The rate was 3.64 percent as of 2:08 p.m. today in Tokyo. The economy will grow 3.2 percent in 2011, the fastest pace since 2004, according to another poll.
“People are starting to come to the conclusion that you’ve got a self-sustaining recovery going on here,” said Thomas Girard who helps manage $133 billion in fixed income at New York Life Investment Management in New York. “When interest rates start to go back up because of the normal business cycle, debt service costs have the potential to just skyrocket. Every day that we don’t address this in a meaningful way it gets more and more dangerous.”

‘Kind of Disruption’

While yields on the benchmark 10-year note are up, they remain below the average of 4.14 percent over the past decade as Europe’s debt crisis bolsters investor demand for safer assets, Bank of America Merrill Lynch index data show.
“The market is still giving the U.S. government the benefit of the doubt,” said Eric Pellicciaro, New York-based head of global rates investments at BlackRock Inc., which manages about $3.56 trillion in assets. “What we’re concerned with is whether the budget will only be corrected after the market has tested them. Will we need some kind of disruption within the bond market before they’ll actually do anything.”
Still, U.S. spending on debt service accounts for 1.7 percent of its GDP compared with 2.5 percent for Germany, 2.6 percent for the United Kingdom and a median of 1.2 percent for AAA rated sovereign issuers, according to a study by Standard & Poor’s published Dec. 24. Among AA rated nations, China’s ratio is 0.4 percent, while Japan’s is 2.9 percent, and for BBB rated countries, Mexico devotes 1.7 percent of its output to debt service and Brazil 5.2 percent, the report shows.

Auction Demand

Demand for Treasuries remains close to record levels at government debt auctions. Investors bid $3.04 for each dollar of bonds sold in the government’s $178 billion of auctions last month, the most since September, according to data compiled by Bloomberg. Indirect bidders, a group that includes foreign central banks, bought a record 71 percent, or $17 billion of the $24 billion in 10-year notes offered on Feb. 9.
Foreign holdings of Treasuries have increased 18 percent to $4.35 trillion through November. China, the largest overseas holder, has increased its stake by 0.1 percent to $895.6 billion, and Japan, the second largest, boosted its by 14.6 percent to $877.2 billion.

‘Killing Itself’

“China cannot dump Treasuries without killing itself,” said Michael Cheah, who oversees $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. “They’re holding Treasuries as a means to an end,” said Cheah, who worked at the Singapore Monetary Authority from 1982 through 1999, and now teaches finance classes at New York University and at Chinese universities. “It’s part of what’s needed to promote exports.”
At least some of the increase in interest expense is related to an effort by the Treasury to extend the average maturity of its debt when rates are relatively low by selling more long-term bonds, which have higher yields than short-term notes. The average life of the U.S. debt is 59 months, up from 49.4 months in March 2009. That was the lowest since 1984.
The U.S. produced four budget surpluses from 1998 through 2001, the first since 1969, as the expanding economy, declining rates and a boom in stock prices combined to swell tax receipts.
Tax cuts in 2001 and 2003, the strain of the Sept. 11 terror attacks, the cost of funding wars in Afghanistan and Iraq, the collapse in home prices and the subsequent recession and financial crisis has led to the three largest deficits in dollar terms on record, totaling $3.17 trillion the past three years.

‘Demonstrates Confidence’

The U.S. needs to manage its spending decisions “in a way that demonstrates confidence to investors so we can bring down our long-term fiscal deficits, because if we don’t do that, it’s going to hurt future growth,” Treasury Secretary Timothy F. Geithner said in Washington on Feb. 9.
The Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Soros Fund Management LLC, expressed concern in the Feb. 1 report that the U.S. is exposing itself to the risk that demand erodes unless it cultivates more domestic demand.
“A more diversified debt holder base would prepare the Treasury for a potential decline in foreign participation,” the report said.
Foreign investors held 49.7 percent of the $8.75 trillion of public Treasury debt outstanding as of November, down from as high as 55.7 percent in April 2008 after the collapse of Bear Stearns Cos., according to Treasury data.

Potential Demand

The committee projects there may be $2.4 trillion in latent demand for Treasuries from banks, insurance companies and pension funds as well as individual investors. New securities with maturities as long as 100 years, as well as callable Treasuries or bonds whose principal is linked to the growth of the economy might entice potential lenders, the report said.
“They are opening up a can of worms with the idea of all these other instruments,” said Tom di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “They should try to keep the Treasury issuance as simple as possible. The more issuance you have in particular issue, the more people will trade them -- whether it be domestic or foreign investors.”
White House Budget Director Jacob Lew said the Obama administration’s 2012 budget would save $1.1 trillion over the next 10 years by cutting programs to rein in a deficit that may reach a record $1.5 trillion this year.
“We have to start living within our means,” Lew said yesterday on CNN’s “State of the Union” program.
Still, about $4.5 trillion, or 63 percent of the $7.2 trillion in public Treasury coupon debt, needs to be refinanced by 2016. That gives the government a narrowing window as growing interest expense will curtail its ability to spend.
“There is roll-over risk,” said James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York, one of 20 primary dealers that trade with the Fed. “It’s a vicious cycle.”

"Obama's Policy is Flip Followed By Flop"