Consumer Spending Jumps, But Where Did They Get The Money?

Economists recently increased their estimates for GDP growth in 2011 after retail sales jumped in December. Did wages jump, no. Did employment jump, no. So where did these consumers get the money?

I don’t think consumers got it from paying off old debts. The consumer debt to disposable income ratio has dropped from 15 percent to 13.96 percent over the past three years (but mostly due to reduced interest rates). The amount of debt remains very high. It has dropped 3.5% over the last two years, but it has only dropped from $13.92 trillion to $13.42 trillion (and much less home equity to offset that debt.)

So it’s pretty obvious consumers received this new money from the government. Maybe the new near $900 billion dollar, December stimulus program (tax cuts, payroll tax deduction, extended unemployment benefits, accelerated depreciation, etc.). Or the $100 billion dollar a month deficit we are financing. Or the monthly $75 billion dollar Quantitative Easing (economist talk for printing money) program under way by the Federal Reserve.

Much of this money will go to either propping up GDP or increasing GDP. Either way, it’s just like the stimulus program, it’s temporary. That is unless we get new, temporary, “investments” (political talk for spending) in the months ahead.

Are Bonds (Fixed Income) at a Tipping Point? Part Duo

The first of November, my Market Update asked if bonds were at a tipping point because they were not responding as Fed Chairman Bernanke wanted (lower interest rates, lower dollar and increased commodity prices.) I also said that we would know more within the next few months.

Since then, the 10 year Treasury has moved down very slightly or about 20 basis points (0.20). However, the yield curve has steepened (short rates down and long rates higher.) Not what Bernanke wanted (unless he wanted to make the environment for bank profits better.)

The dollar has been rising not falling. But the problem is that other countries are not going to simply sit back and let the U.S. devalue the dollar (to improve exports), so they have responded by devaluing their currency in order to compete. This currency war can’t go on forever, but in the meantime, it is destructive.

Commodity prices are about the same.

It seems that there is no definitive answer yet, but there is a lot of new money going into the banking system and the banks have three choices of what to do with the money:

1.Sit on these new assets and collect the overnight interest rate from the Federal Reserve, or
2.Lend this money out to companies and individuals who want to borrow money. There is not much of this going on because banks are sitting on nearly a trillion dollars of excess assets, (maybe banks don’t want to lend or maybe borrowers don’t want to borrow.) or
3.Buy assets with this money (bonds, stocks, commodities, foreign investments, etc.) Contrary to what many people think, banks do not need to lend money to borrowers to make profits, they can invest the money here and abroad, wherever they can make the most money.

Another thing that seems to be going on here is that we have not seen much inflation (by government statistics) in spite of all the new money that’s been created. The reason many people think is that inflation will not happen until those trillions of dollars in excess assets get turned into trillions of dollars of credit.

So, think about this, if the economy does turn around or people think it has turned around; and suddenly want to use credit, would those trillions of dollars of credit turn into instant inflation? If so, that may not be good for the bond (fixed income) market as investors will want to be paid for the inflation risk.

More Money Or Less Money In 2011, That's The Key

Will 2011 be the year the US creates massive amounts of new money to "solve" our problems and temporarily levitate our GDP? Or the year of austerity and GDP contraction? It seems to me the key to 2011 is more money or less money.

Economists, politicians and pundits have developed lists and lists of problems, strategies, and opportunities we face in the coming year; and there are many. With a few exceptions, they all seem to boil down to money.

Will the government decide that it has to create or print more money, even though we know we have to borrow it and worry about the burdensome debt later. By the way, the government just added about a trillion dollars in additional debt with the "tax compromise" bill they passes just before Christmas. If we print more money, the argument goes, we could:

1.Get the debt ceiling limit of $14 trillion raised before we reach it in March
2.Pay for the estimated budget deficit of $1.5 to $2.0 trillion again this year
3.Transfer money to the states so they could meet their out-of-control budgets. They will be about $200-400 billion dollars short this year and next.
4.Try to get our arms around the housing problem. The billions of dollars spent to date haven't solved the problem and now we could be looking at a double dip in housing.
5.The additional money banks will need if housing prices continue to decline causing millions more defaults and foreclosures
6.Add more government spending (stimulus) to fill the spending gap caused by consumers lack of spending.

Or will the government decide to cut spending and save the country from default or hyperinflation. Contraction of the money supply however, will cause GDP (the mathematical model we use to represent the economy) to decline. And yes, money contraction is deflation. That's how we get to equilibrium so we can get this recession over.

Within the first three months of this new congress we should know which direction our government central planners intend to go. Make plans. Be ready.