Update On Scenario One

This remains the most probable scenario at this time (of my four total scenarios.) However, other scenarios are possible depending on what the government and central banks do (more money creation or money contraction) and what banks do (possible trillions in credit to consumers which is money creation) and how individuals react (credit defaults, savings, leverage, etc.)

1. March 2010 (massive increases in money supply which artificially and temporarily increases GDP but results in malinvestments or bubbles)

a. Interest rate reduction
b. Stimulus Programs
c. Mark-to –Market rules revised (allowing banks to increase value of mortgage bonds)
d. Central Bank buys “toxic bonds” from banks (QE1) increasing ”excess reserves” at banks to $1.1 trillion from $4 billion.
e. November 2010, QE2 begins ($600 billion more pumped into banks but most of it goes into European banks)
f. Money supply increases at double digit rates for 28 of last 29 months

2. May 2011

a. Stimulus ending in June
b. QE2 ending in June (both a and b will contract money supply which will reduce GDP)
c. Debt ceiling “argument” (raise limit by $2-3 trillion or austerity) deadline by August 2

3. Labor Day (+/-) or possibly sooner depending on our central planners (government and the Central Bank

a. My guess, debt limit increased with promise to cut spending starting in 2013 (after next elections) Raising the debt limit is priced into the markets now.
b. As economy drifts lower, pressure for government to “do something.” Therefore, I expect a new stimulus program (significant tax cuts because Republicans will have to vote for them and Democrats will get their stimulus because we will borrow the money displaced by the tax cuts)
c.New QE3 program (large) so central bank can continue to buy bonds and keep interest rates low (for housing, employment, etc.) This may be called something else so it can be framed differently for public consumption.
d.Timing of new stimulus for 2012 elections will become important to allow for lag time and momentum prior to elections.

4. Top of Bubble (then significant recession)

5. S&P500 down to about 650-600

The Next Three Months

June 10, 2011

The economy, meaning the GDP or consumption model, is struggling to say the least. The government has been pouring money into the economy trying to keep it from adjusting to its natural (equilibrium) level after the artificial high encored during the buildup of the bubble.

Now, the flow of money is scheduled to stop (stimulus money by the end of June, the Fed printing money by June 30), and reaching the debt limit ($14.2 trillion) for the 140th time. Now what’s going to happen: more money or austerity? It seems everyday the market flips back and forth.

On Monday, it appears that austerity is on the way which will reduce GDP (and revenues and profits) but the Fed will keep interest rates low “for an extended period of time.” Therefore, the markets react by buying the dollar and chasing high interest rates and selling stocks and commodities. The price swings are big but the intensity of buys and sells is not there.

On Tuesday, the mood swings and traders are convinced that the “government will do something” (more stimulus, additional tax reductions, more printing of money by the Fed, etc.) Therefore, the markets react by pushing up the stocks and commodities, selling off the dollar and high interest rate securities. Again, big price swings but not much intensity.

This may go on for the next three months or until it become clear what the government will do. Therefore, for the next three months you may be limited to very short trades or waiting for the printing presses to start rolling again. Based on how the political class has acted since 1913, I am not going to hold my breath for a balanced budget.

What Slow Patch? Aren’t We Still In A Recession?

With the bad economic numbers we have been getting lately (employment, housing, manufacturing, etc.), the economy appears to be turning down again.

Consensus among mainstream economists is that the “recovery” is only entering a “slow patch” as we transition from a government funded recovery back to a private sector funded economy. The reason for this “slow patch” is that stimulus programs are running out of money and the Fed’s QE2 program is ending in June. Therefore, we have to be patient as the “real” economy continues to grow.

The real question is “Aren’t we still in a recession? We have spent trillions of dollars and all we have to show for it is debt. Now, we are going to have to go through a “slow down?”

Let’s face reality. Either the government gets out of the way and lets the economy reach equilibrium, as painful as that would be; or we borrow and spend more money to keep our economy growing at 1% (stagflation level). My guess is that the government will spend more without cutting or saying they will start to cut in 2014 (when they are all retired.)

Hit reply and tell me what you think:
Will they cut spending?
Will they spend even more?

There is one other thing they could try. They could stop looking short-term (definition: days to next election) or they could look at the cause of the recession (government intervention, spending on the flavor of the month, the tax code, trillions of unnecessary regulations, manipulation of interest rates, etc., etc.) That is what caused the bubble in the first place. Now, we are in the process of doing it over again. It’s time to re-think our priorities first, then budget levels.