Worker Bees Now Outnumbered By Drones

This Is What a Bubble Looks Like!

How QE Is Likely to End and Why Commodities Are Still In a Secular Bull Market

from The Future Tense blog. I agree with every word of this:

We are rapidly approaching the point of "peak debt" globally. This has been referred to here on this site as the end of the debt super cycle, which began over 70 years ago.

The end of the debt super cycle means that many of the developed economies that have used debt to create growth will no longer have the ability to service their current debt or take on additional leverage. The debt of a country can be seen at the individual (consumer), corporate, banking, and government level.

In the United States the total debt in relation to the size of the overall economy (debt to GDP ratio) reached  370% in 2008 before it peaked.

This chart is certainly troublesome as it shows how far the United States still has remaining in the deleveraging process to bring the debt back to healthy/manageable levels. A reduction of just 20 basis points on this 370% debt to GDP ratio has put the country into a depression, temporarily masked by government spending and quantitative easing . Imagine what would occur if real a deleveraging took place? Here is the chart again with banking (financial) debt removed, showing the three remaining categories (GSE's are Fannie Mae, Freddie Mac, and Sallie Mae which can be considered part of government debt). Click for larger image.

Now for the scary part. The United States balance sheet looks like a time bomb waiting to explode (and it will), but viewed against the rest of the world the U.S. is not even the worst offender.

The following shows that the balance sheet for Japan, the U.K. and the Eurozone is far worse than the United States.

Does this make the United States debt situation more attractive? Of course not. It only shows that the current debt super cycle is a global phenomenon. Each one of these four developed regions (which make up the lion's share of global GDP) are approaching the point where they will have hit "peak debt," as the private portion of the U.S. balance sheet did in 2008.

The first question is always, with such staggering debt levels why has this not occurred already? This same question was posed for those who argued that the real estate market was in danger back in 2004 and 2005 as there appeared to be no issues on the surface.

The answer is that these countries have had the ability to roll existing debt (similar to refinancing a home) and borrow new debt (another buyer purchasing a home at a greater price) at ultra low interest rates. Just as the housing market reached its maximum point of leverage when interest rates rose, the same will occur on a much larger scale for the entire debt market across the developed world.

The next question is; Central banks are holding interest rates down with their QE programs in the United States, Europe, Japan, and the U.K. With the ability to print an endless amount of money, can't they just keep rates down forever?

The answer is no. Ultimately the market is going to overpower the central banks. This can occur in multiple ways. One way would be for investors to simply get nervous (or understand) that the debt they are holding fundamentally has no value as it is impossible for these debtors to ever repay. We could wake up any day to a very sharp sell off in the bond market for one of the bankrupt developed nations. The problem with debt markets, which can be seen in the case of Lehman Brothers below, is that while stocks tend to track down in a linear fashion, bonds are more likely to collapse overnight. Investors believe up to the very last minute that they have most of their value, until they don't.

A second scenario could occur if some of the trillions of paper currency currently being printed by central banks globally began to move toward commodities. So far during this QE experiment money has flooded into paper assets globally (specifically the US stock market) and real estate (globally and more recently the United States).

Commodities prices have not received the benefit of this freshly printed money. Since 2011, the major commodities have fallen in an almost steady trajectory. They have become the most hated asset class on the planet (considered by many to be in a new secular bear market).

The following shows the steady decline of the major metals since 2011:

The next chart shows the entire commodities index since the secular bull market began in 2000. There was a cyclical rise into 2011 and a steady and relentless decline since that peak. Hedge funds have slowly off loaded their commodity positions and many commodity based funds have even shut their doors over the past few weeks.

A secular bull market usually moves through five waves during its completion. This is called the Elliott Wave cycle. The second and fourth waves of the cycle are correction (downward waves). We experienced wave one up from 2000 to 2008, corrected into early 2009 (wave two), then experienced the second wave up (wave 3) into 2011. We have been in the second corrective wave down (wave 4) since .

How low will this wave go before it completes? Based on the chart above it could fall much further. However, as just discussed, pessimism within the sector has reached incredible levels. I like to buy assets that I believe are in secular bull markets when they have declined in price and sentiment is low. This usually causes me to begin buying before a bottom is in place.

New money created by the central banks around the world has flooded into paper assets. If some of that money were to rotate into commodities it would put the bottom in on the current cyclical move downward.

This brings us back to what could potentially slow the QE purchases globally. If commodity prices begin to rise it creates inflation in assets that people use during a day to day basis (unlike the inflation seen in the paper financial markets thus far during the global QE experiment). If real inflation rises (gasoline, food, utilities, health care, or the goods purchased at the store), investors will demand a greater return on their money to compensate for inflation risks. This will cause yields to rise, and it will reveal the true corner that the Federal Reserve and other central banks have painted themselves into.

This process will bring about the endgame of the debt super cycle. A new monetary system is put in place about every 40 years and the current one began in 1971. We are overdue for what has occurred naturally throughout history. This will not bring about the end of the world, it will just bring change. Those that understand it is coming will take advantage of the short term chaos and purchase assets at inexpensive prices (the paper and real estate assets currently back at bubble prices).

For more on the corner the Fed has painted itself into see: The Coming End To The Fed's Illusion

 
h/t MISH, Short Side Of Long, ZH

Lacy Hunt: Fed Policy Failures Are Mounting

Federal Reserve Policy Failures Are Mounting

The Fed's capabilities to engineer changes in economic growth and inflation are asymmetric. It has been historically documented that central bank tools are well suited to fight excess demand and rampant inflation; the Fed showed great resolve in containing the fast price increases in the aftermath of World Wars I and II and the Korean War. In the late 1970s and early 1980s, rampant inflation was again brought under control by a determined and persistent Federal Reserve.
However, when an economy is excessively over-indebted and disinflationary factors force central banks to cut overnight interest rates to as close to zero as possible, central bank policy is powerless to further move inflation or growth metrics. The periods between 1927 and 1939 in the U.S. (and elsewhere), and from 1989 to the present in Japan, are clear examples of the impotence of central bank policy actions during periods of over-indebtedness.
Four considerations suggest the Fed will continue to be unsuccessful in engineering increasing growth and higher inflation with their continuation of the current program of Large Scale Asset Purchases (LSAP):

• First, the Fed's forecasts have consistently been too optimistic, which indicates that their knowledge of how LSAP operates is flawed. LSAP obviously is not working in the way they had hoped, and they are unable to make needed course corrections.
• Second, debt levels in the U.S. are so excessive that monetary policy's traditional transmission mechanism is broken.
• Third, recent scholarly studies, all employing different rigorous analytical methods, indicate LSAP is ineffective.
• Fourth, the velocity of money has slumped, and that trend will continue—which deprives the Fed of the ability to have a measurable influence on aggregate economic activity and is an alternative way of confirming the validity of the aforementioned academic studies.

1. The Fed does not understand how LSAP operates
If the Fed were consistently getting the economy right, then we could conclude that their understanding of current economic conditions is sound. However, if they regularly err, then it is valid to argue that they are misunderstanding the way their actions affect the economy.
During the current expansion, the Fed's forecasts for real GDP and inflation have been consistently above the actual numbers. Late last year, the midpoint of the Fed's central tendency forecast projected an increase in real GDP of 2.7% for 2013—the way it looks now, this estimate could miss the mark by nearly 50%.
One possible reason why the Fed have consistently erred on the high side in their growth forecasts is that they assume higher stock prices will lead to higher spending via the so-called wealth effect. The Fed's ad hoc analysis on this subject has been wrong and is in conflict with econometric studies. The studies suggest that when wealth rises or falls, consumer spending does not generally respond, or if it does respond, it does so feebly. During the run-up of stock and home prices over the past three years, the year-over-year growth in consumer spending has actually slowed sharply from over 5% in early 2011 to just 2.9% in the four quarters ending Q2.
Reliance on the wealth effect played a major role in the Fed's poor economic forecasts. LSAP has not been able to spur growth and achieve the Fed's forecasts to date, and it certainly undermines the Fed's continued assurances that this time will truly be different.
2. US debt is so high that Fed policies cannot gain traction
Another impediment to LSAP's success is the Fed's failure to consider that excessive debt levels block the main channel of monetary influence on economic activity. Scholarly studies published in the past three years document that economic growth slows when public and private debt exceeds 260% to 275% of GDP. In the U.S., from 1870 until the late 1990s, real GDP grew by 3.7% per year. It was during 2000 that total debt breached the 260% level. Since 2000, growth has averaged a much slower 1.8% per year.
Once total debt moved into this counterproductive zone, other far-reaching and unintended consequences became evident. The standard of living, as measured by real median household income, began to stagnate and now stands at the lowest point since 1995. Additionally, since the start of the current economic expansion, real median household income has fallen 4.3%, which is totally unprecedented. Moreover, both the wealth and income divides in the U.S. have seriously worsened.
Over-indebtedness is the primary reason for slower growth, and unfortunately, so far the Fed's activities have had nothing but negative, unintended consequences.
3. Academic studies indicate the Fed's efforts are ineffectual
Another piece of evidence that points toward monetary ineffectiveness is the academic research indicating that LSAP is a losing proposition. The United States now has had five years to evaluate the efficacy of LSAP, during which time the Fed's balance sheet has increased a record fourfold.
It is undeniable that the Fed has conducted an all-out effort to restore normal economic conditions. However, while monetary policy works with a lag, the LSAP has been in place since 2008 with no measurable benefit. This lapse of time is now far greater than even the longest of the lags measured in the extensive body of scholarly work regarding monetary policy.
Three different studies by respected academicians have independently concluded that indeed these efforts have failed. These studies, employing various approaches, have demonstrated that LSAP cannot shift the Aggregate Demand (AD) Curve. The AD curve intersects the Aggregate Supply Curve to determine the aggregate price level and real GDP and thus nominal GDP. The AD curve is not responding to monetary actions, therefore the price level and real GDP, and thus nominal GDP, are stuck—making the actions of the Fed irrelevant.
The papers I am talking about were presented at the Jackson Hole Monetary Conference in August 2013. The first is by Robert E. Hall, one of the world's leading econometricians and a member of the prestigious NBER Cycle Dating Committee. He wrote, "The combination of low investment and low consumption resulted in an extraordinary decline in output demand, which called for a markedly negative real interest rate, one unattainable because the zero lower bound on the nominal interest rate coupled with low inflation put a lower bound on the real rate at only a slightly negative level."
Dr. Hall also wrote the following about the large increase in reserves to finance quantitative easing: "An expansion of reserves contracts the economy." In other words, not only have the Fed not improved matters, they have actually made economic conditions worse with their experiments. Additionally, Dr. Hall presented evidence that forward guidance and GDP targeting both have serious problems and that central bankers should focus on requiring more capital at banks and more rigorous stress testing.
The next paper is by Hyun Song Shin, another outstanding monetary theorist and econometrician and holder of an endowed chair at Princeton University. He looked at the weighted-average effective one-year rate for loans with moderate risk at all commercial banks, the effective Fed Funds rate, and the spread between the two in order to evaluate Dr. Hall's study. He also evaluated comparable figures in Europe. In both the U.S. and Europe these spreads increased, supporting Hall's analysis.
Dr. Shin also examined quantities such as total credit to U.S. non-financial businesses. He found that lending to non-corporate businesses, which rely on the banks, has been essentially stagnant. Dr. Shin states, "The trouble is that job creation is done most by new businesses, which tend to be small." Thus, he found "disturbing implications for the effectiveness of central bank asset purchases" and supported Hall's conclusions.
Dr. Shin argued that we should not forget how we got into this mess in the first place when he wrote, "Things were not right in the financial system before the crisis, leverage was too high, and the banking sector had become too large." For us, this insight is highly relevant since aggregate debt levels relative to GDP are greater now than in 2007. Dr. Shin, like Dr. Hall, expressed extreme doubts that forward guidance was effective in bringing down longer-term interest rates.
The last paper is by Arvind Krishnamurthy of Northwestern University and Annette Vissing-Jorgensen of the University of California, Berkeley. They uncovered evidence that the Fed's LSAP program had little "portfolio balance" impact on other interest rates and was not macro-stimulus. A limited benefit did result from mortgage-backed securities purchases due to the announcement effects, but even this small plus may be erased once the still unknown exit costs are included.
Drs. Krishnamurthy and Vissing-Jorgensen also criticized the Fed for not having a clear policy rule or strategy for asset purchases. They argued that the absence of concrete guidance as to the goal of asset purchases, which has been vaguely defined as aimed toward substantial improvement in the outlook for the labor market, neutralizes their impact and complicates an eventual exit. Further, they wrote, "Without such a framework, investors do not know the conditions under which (asset buys) will occur or be unwound." For Krishnamurthy and Vissing-Jorgensen, this "undercuts the efficacy of policy targeted at long-term asset values."
4. The velocity of money—outside the Fed's control
The last problem the Fed faces in their LSAP program is their inability to control the velocity of money. The AD curve is planned expenditures for nominal GDP. Nominal GDP is equal to the velocity of money (V) multiplied by the stock of money (M), thus GDP = M x V. This is Irving Fisher's equation of exchange, one of the important pillars of macroeconomics.
V peaked in 1997, as private and public debt were quickly approaching the nonproductive zone. Since then it has plunged. The level of velocity in the second quarter is at its lowest level in six decades. By allowing high debt levels to accumulate from the 1990s until 2007, the Fed laid the foundation for rendering monetary policy ineffectual. Thus, Fisher was correct when he argued in 1933 that declining velocity would be a symptom of extreme indebtedness just as much as weak aggregate demand.
Fisher was able to make this connection because he understood Eugen von Böhm-Bawerk's brilliant insight that debt is future consumption denied. Also, we have the benefit of Hyman Minsky's observation that debt must be able to generate an income stream to repay principal and interest, thereby explaining that there is such a thing as good (productive) debt as opposed to bad (non-productive) debt. Therefore, the decline in money velocity when there are very high levels of debt to GDP should not be surprising. Moreover, as debt increases, so does the risk that it will be unable to generate the income stream required to pay principal and interest.
Perhaps well intended, but ill advised
The Fed's relentless buying of massive amounts of securities has produced no positive economic developments, but has had significant negative, unintended consequences.
For example, banks have a limited amount of capital with which to take risks with their portfolio. With this capital, they have two broad options: First, they can confine their portfolio to their historical lower-risk role of commercial banking operations—the making of loans and standard investments. With interest rates at extremely low levels, however, the profit potential from such endeavors is minimal.
Second, they can allocate resources to their proprietary trading desks to engage in leveraged financial or commodity market speculation. By their very nature, these activities are potentially far more profitable but also much riskier. Therefore, when money is allocated to the riskier alternative in the face of limited bank capital, less money is available for traditional lending. This deprives the economy of the funds needed for economic growth, even though the banks may be able to temporarily improve their earnings by aggressive risk taking.
Perversely, confirming the point made by Dr. Hall, a rise in stock prices generated by excess reserves may sap, rather than supply, funds needed for economic growth.
Incriminating evidence: the money multiplier
It is difficult to determine for sure whether funds are being sapped, but one visible piece of evidence confirms that this is the case: the unprecedented downward trend in the money multiplier.
The money multiplier is the link between the monetary base (high-powered money) and the money supply (M2); it is calculated by dividing the base into M2. Today the monetary base is $3.5 trillion, and M2 stands at $10.8 trillion. The money multiplier is 3.1. In 2008, prior to the Fed's massive expansion of the monetary base, the money multiplier stood at 9.3, meaning that $1 of base supported $9.30 of M2.
If reserves created by LSAP were spreading throughout the economy in the traditional manner, the money multiplier should be more stable. However, if those reserves were essentially funding speculative activity, the money would remain with the large banks and the money multiplier would fall. This is the current condition.
The September 2013 level of 3.1 is the lowest in the entire 100-year history of the Federal Reserve. Until the last five years, the money multiplier never dropped below the old historical low of 4.5 reached in late 1940. Thus, LSAP may have produced the unintended consequence of actually reducing economic growth.
Stock market investors benefited, but this did not carry through to the broader economy. The net result is that LSAP worsened the gap between high- and low-income households. When policy makers try untested theories, risks are almost impossible to anticipate.
The near-term outlook
Economic growth should be very poor in the final months of 2013. Growth is unlikely to exceed 1%—that is even less than the already anemic 1.6% rate of growth in the past four quarters.
Marked improvement in 2014 is also questionable. Nominal interest rates have increased this year, and real yields have risen even more sharply because the inflation rate has dropped significantly. Due to the recognition and implementation lags, only half of the 2013 tax increase of $275 billion will have been registered by the end of the year, with the remaining impact to come in 2014 and 2015.
Additionally, parts of this year's tax increase could carry a negative multiplier of two to three. Currently, many of the taxes and other cost burdens of the Affordable Care Act are in the process of being shifted from corporations and profitable small businesses to households, thus serving as a de facto tax increase. In such conditions, the broadest measures of inflation, which are barely exceeding 1%, should weaken further. Since LSAP does not constitute macro-stimulus, its continuation is equally meaningless. Therefore, the decision of the Fed not to taper makes no difference for the outlook for economic growth.
***
Dr. Lacy Hunt, executive VP of Hoisington Investment Management Company, is an internationally known economist. Before his position at HIMCO, he served as senior economist for the Federal Reserve in Dallas, and as chief US economist for HSBC Group.
Dr. Hunt was one of the blue-ribbon speakers at the just-concluded Casey Research Summit in Tucson, AZ, and his presentation was voted to be "the scariest speech" of the Summit by many attendees. However, Dr. Hunt was only one of the many experts—among them James Rickards, Bud Conrad, and Chris Martenson—who warned of the dire consequences of the Fed's prolonged manipulation of the US economy. Listen to the entire Summit, including timely investment advice and specific stock picks, in the comfort of your home. More here…

Dollar Debacle

Optimism Rife On Wall St, Despite "Inconclusive" Meeting At White House

S&P down modestly.

...But Wall St Is Hearing None of That

The financial markets today are focused on a meeting that Obama and House GOP leadership have a meeting scheduled that is likely to bring another kicking of the debt can, at best. The Dow was up more than 200 points a few minutes ago. The bond market is expecting a six week can kick.

Jobless Claims Spike to Highest In Months

Weekly jobless claims spiked to the highest levels since March this morning.

from the WSJ:

Global PC Sales Plunge 8.6%

from Gartner:
Worldwide PC shipments totaled 80.3 million units in the third quarter of 2013, an 8.6 percent decline from the same period last year, according to preliminary results by Gartner, Inc. This marks the sixth consecutive quarter of declining worldwide shipments.
"The third quarter is often referred to as the 'back-to-school' quarter for PC sales, and sales this quarter dropped to their lowest volume since 2008," said Mikako Kitagawa, principal analyst at Gartner. "Consumers' shift from PCs to tablets for daily content consumption continued to decrease the installed base of PCs both in mature as well as in emerging markets. A greater availability of inexpensive Android tablets attracted first-time consumers in emerging markets, and as supplementary devices in mature markets."

But Wall St is oblivious. The focus today is on a meeting between Obama and the House GOP leadership that may resolve the budget and debt impasse. The Dow was up 200+ points a few minutes ago.

Stocks Goosed Higher Despite Ongoing Budget/Debt Impasse

Between the dovish Yellen nomination, and the IMF virtually pleading for more money printing, stocks are now moving modestly higher. Dow up today.

IMF Presses for Even MORE Fed "Unprecedented Measures"

Obama's Gives Yellen the Nod As Fed Chair

from the WSJ:

Even the Wall St Journal recognizes that Yellen is going to push the envelope and risk even greater dislocations. And WE are their guinea pigs in this grand experiment!

Will There Be Treasuries Issued Next Week?

Treasury bills have maturities of anywhere from a few days to 52 weeks. Treasury notes have maturities of between two years and ten years. Treasury bonds have maturities of 30 years. And the Treasury also sells Treasury-Inflation Protected Securites (TIPS), which have terms of 5, 10 or 30 years.

Cotton Prices Crushed As Storm Weakens

via Reuters in Mumbai, India:
Oct 7 (Reuters) - Cotton futures in India, the world's second-largest grower, are expected to fall this week on hopes of higher output as rains lead to better yields and due to approaching supplies from the new season harvest amid sluggish exports.

by Reuters US:

* Dissipating Tropical Storm leaves cotton crops unscathed
* Fiber sinks to one-month low, extends losses on sell stops
* Global stocks slide as investors remain jittery over U.S. gov't shutdown
* USDA will not release World Agricultural Supply and Demand Estimates report on Friday
NEW YORK, Oct 7 (Reuters) - ICE cotton sank on Monday to post its biggest loss in over six weeks as the weakening of Tropical Storm Karen eased worry over crop damage in the United States, the world's top exporter, and as the U.S. government shutdown and budget impasse kept investors skittish.

Cocoa Continues to Rise Due to Global Long-Term Supply Pressures

from Bloomberg:
Money managers raised bullish bets on cocoa traded in London to a record as global shortages loom for the 2013-14 season that started this month, according to data from NYSE Liffe, the derivatives arm of NYSE Euronext.
Investors were net-long, or betting on higher prices, by 64,759 futures and options in the week ended Oct. 1, the Commitments of Traders report on the exchange’s website showed today. That was the largest bullish bet since publishing of trader holdings began in 2011 and compared with the previous record of 63,419 contracts in the week ended Sept. 24. The beans for December delivery fell 0.5 percent in the latest week.

from  the Business Recorder of Pakistan:

NEW YORK: ICE cocoa climbed to a more than one-year high and London futures rallied to the highest in about two years on Monday as the International Cocoa Organization forecast a deficit in the next four years and as recent rains stoked worry of supply concerns in West Africa, the world's top growing region.

 by the Public Ledger of Agra.net:
Cocoa futures closed significantly higher on Monday, underpinned by reports that global demand will outstrip supply, industry watchers said.
According to the International Cocoa Organization (ICCO), the global cocoa deficit will be 69,000-70,000 metric tonnes in 2013/14, up from 52,000 tonnes in 2012/13.

Corn Leaps Due to Storm Risk

Wheat and corn futures rose Monday after storms in the Midwest over the weekend threatened both crops.
Wheat for December delivery rose 7.75 cents to $6.9475 a bushel and December corn rose 6 cents to $4.4925 a bushel.
Weekend storms delayed the harvest of the corn crop and also caused delays in planting the winter wheat crop, said Todd Hultman, a grain analyst with DTN/The Progressive Farmer in Omaha, Neb.

Stocks Sink Into the Close

News that a major broker doubled stock futures margins, along with the pressure of the continuing budget impasse in Washington, sank stock markets in the last hour of trading today, with the Dow closing down 136 points.

This was somewhat surprising, given that stocks had rallied out of the starting gate from deep losses, cutting those losses in half by mid-day.

Budget Impasse Doesn't Worry Wall St

Dow opened down more than 130 points, but is rallying sharply at the open. The continuing budget impasse doesn't appear to worry Wall St.

Stocks Decline Sharply Overnight, Rally At Open

Stocks Down 9 of Past 11 Days