The Debt Ceiling Has Been Reached Again

December 27, 2012

Treasury Secretary Geithner announced today that we would reach the debt ceiling on December 31. 2012.  However, he has some options -like postponing payments to pension plans- that will keep us from defaulting until as late as April.
 
President Obama would like the debt ceiling raised as part of the "Fiscal Cliff" agreement. Rather than come to congress every time the debt ceiling is reached, Mr. Obama would like Congress to give the President authority to raise the debt-ceiling limit whenever it was needed. The Republicans proposed this once in the past as well. I do not think this can pass the House at this time.
 
Incidentally, the debt ceiling came out of the debate to establish the Federal Reserve in 1913.  Congress was worried that the government would spend and the Federal Reserve would print too much money debasing the dollar and destroying purchasing power. So In order to get the votes needed to establish the Federal Reserve, Congress passed a bill limiting the amount of Sovereign debt that could be issued to $2 billion dollars.  We are now talking $18 trillion as a stopgap measure. 
 
In any event, the debt ceiling will probably be part of the Fiscal Cliff negotiations.  If you remember the last time we debated the debt ceiling, it took a 10% market correction before the politicians got serious.  Also, we might see S&P start talking about another credit rating downgrade if it seems that the political parties cannot get something done. It may be different this time, but keep your positions hedged if possible.   

The Great Disconnect

December 24, 2012

Several recent events indicate that financial companies may be, once again, coming into favor. But remember, caution and hedging are required in our noise driven, centrally planned world.     

1. A week ago, the Federal Reserve increased the amount of money they are creating from $40 billion a month to $85 billion a month. That's $1trillion more dollars going into the banking system over the next year. This will enable the banks to get rid of a lot of toxic assets and allow them to reclassify assets which will increase their excessive reserves (they have over $1.4 trillion now) and reduce reserve requirements (think bank profits).
2. At the same time, the Central Banks have a coordinated, multi-national Central Bank lending/currency program to help shore up sovereign debt.
3. Last week, Greek sovereign debt was upgraded and their credit rating moved up to stable (they did get part of the $16 billion they need to pay bankers). Result: Greek bond spreads narrowed and Europe equities rallied.
4. A few days ago, Meredith Whitney (a key bank analyst) put a buy on BAC and Citi. She stated that after the next stress tests, BAC should be able to buy back stock, raise its dividend and add billions in capital. One of her reasons is that they have worked off a lot of bad assets.
5. Also, the market thinks a deal will be made on the Fiscal Cliff in that taxes will be raised and spending cuts will be done with smoke and mirrors so there will not be any real cuts (i.e. $350 billion saved in reduced interest costs over the next 10 years, $180 billion saved from Chained CPI numbers for Social Security increases, etc.). Therefore, no immediate cuts and more spending (Sandy relief, a $3.5 trillion budget, $1 trillion in new money by the Fed, etc.) implying that we will not have a recession (negative GDP) in 2013.  

 Net: Thanks to Ben's money, the economy and the markets are on different trajectories. Or to put it another way, the status quo will be maintained at any cost until we meet the black swan.   

Five Thorny Issues In The Next Five Weeks

November 20, 2012

There are several very difficult, very divisive issues that need to be resolve over the next five weeks or four of them will be automatically implemented on January 1, 2013. We know we are going to get higher taxes in 2013 and we may get some spending cuts (but I wouldn't hold my breath for much more than extensions).

Resolved, postponed, or kicked down the road, they should impact (including volatility) the economy and the markets. Following is a summary of these issues so you can begin to prepare for them.

1. The Fiscal Cliff

This is the automatic spending cuts and tax increases that go into effect on January 1, 2013.

The spending cuts amount to 3% of discretionary spending and 3% of defense spending. Per current legislation, the cuts are automatic and politicians cannot pick and choose which items to cut and which items to leave in place. However, as you could guess, they can vote to change anything; and they will because each side is not interested in cutting spending, they are only interested in saving or protecting the spending that is important to them.

Tax increases are also supposed to be automatic. If they are:

Personal income tax rates will rise to 39.5% for the top rate

The Alternative Minimum Tax (ATM) becomes a factor at lower levels

The 2% payroll tax holiday goes away

Estate taxes go back to 55% and for much smaller estates

2. ObamaCare Taxes become effective January 1, 2013

           

            Dividend tax rates go from 15% to your personal income tax rate

            Capital gains tax goes from 15% to 20%

            Investment tax (an additional tax) of 3.8% on dividends

            Exemptions reduced on child care credit and the marriage penalty is back

            Expense limits decrease (what expenses and amounts)

            State and local sales tax deductions are reduced

            1040 deductions reduced (medical)

            Flexible Spending Accounts will be limited to $2,500

            New Medicare wage and salary tax (0.9% above 200,000)

            New Medicare Investment tax of 3.8% (wages above $200,000)

Note: if these remain unchanged, you may have to consult your accountant. This information is only intended to illustrate what might happen and may not apply to any one individual.

3. Debt Ceiling Limit (will be reached before end of year)

This is not a new spending authorization; the increase is for spending which has already been committed to. Last time (last August) this "battle" resulted in a market decline of about 10% and a reduction in the U.S. Credit Rating. The credit agencies have said this new increase without a reduction in spending could result in another credit downgrade which could be a risk to interest rates and bond values.

4. FOMC Meeting and the end of "Twist"

The Federal Open Market Committee (the Fed) meets for its regular meeting on December 12. One thing under consideration will be the "Twist" program which was designed to keep long-term interest rates low and thereby help the housing industry will expire on December 31. Will they renew it, expand it or drop it in favor of something else?

5. Transaction Account Guarantee (TAG) expires December 31, 1212

In the debt crisis, the government (FDIC) raised deposit insurance from $100,000 to $250,000 and made it unlimited for non-interest bearing transaction accounts. When this expires, the estimated $1.4 trillion in cash accounts of corporations and other depositors could leave the small/medium-sized financial firms and go to the large, too-bigger-to-fail firms because they have an implied guarantee.

Election Result: We Want To Maintain The Status Quo, But..

November 6, 2012

After spending $6 billion in platitudes and demagoguery -without addressing a single, important issue - the result of the election was simply to maintain the Status Quo: Democratic President and Senate and Republican House. But now, the President and Congress have to deal with the real issues: spending, revenues and debt.

Mandatory spending (mostly Social Security, Medicare, Medicaid) plus the interest on our debt amount to about $2.5 trillion per year. These are policy programs so the payments are not voted on by Congress, they are made automatically every month just like telling your bank to automatically pay these bills from you checking account each month.

This $2.5 trillion yearly total is paid from federal revenues (mostly taxes) which amount to about $2.5 trillion per year (about 18% of GDP.) Great, except there are 10,000 baby boomers being added to this payroll each month plus the costs of inflation.

But, we still have about $1.2 trillion per year of Discretionary Spending (for things like Defense, Education, Homeland Security, etc.) Since we are out of money, we borrow these funds so we really spend about $3.6 trillion per year, borrow $1.2 trillion and add it to the debt each year.

So, mathematically, how do we solve this problem?

In recent polls, 80% of people want the government to cut spending; 80% of people do not want cuts in mandatory spending; and 66% of people do not want tax increases. Go figure. But we must to do something before our credit card is maxed out.

So after blowing $6 billion on hopium and personal attacks, we are back to raising the debt ceiling and blaming the "other side" for all our problems: The Status Quo.

The Real Debate

October 16, 2012
After watching the debate last night, I had a bunch of questions I thought were important but that were never asked. Here are three of them:

1. Why has the economy (GDP) been trending down for the past two years and the stock market moving up?
The answer of course in that the government has been pumping money into the banks (TARP, QE1, QE2, Twist Program and now QE3 with no limit as to the amount of money they will print.) This money goes to the banks and then the banks use this money to invest in the market (stocks, bonds, foreign investments, etc.). This 65% increase in “green paper” or money has driven the stock market up about 71% from the bottom in February 2009. This is illusionary wealth also called a bubble and like all bubbles, it will pop.

And just to make sure this money will go into assets that raise the value of the market (or what government economist’s call the “wealth effect”) which is suppose to make us run out and spend money; the Federal Reserve has instituted a Zero Interest Rate Policy (ZIRP) to make sure no one saves and is forced to go into the market to earn any interest.

2. How can the government continue to keep spending and driving up debt when mandatory spending (Social Security, Medicare, Medicaid, Other Mandatory spending -like VA benefits, welfare, etc. – and the interest on the debt equal the entire revenue?

In 2012, the government spent $2.5 trillion on mandatory items and interest and received $2.5 trillion in revenues (taxes, tariffs etc.).

That leaves Zero money left for all other discretionary spending ($628t) and defense ($680t). This is more than a trillion dollars a year which means we will likely not even have enough revenues to pay for mandatory spending next year unless the economy picks up.

Follow up question:

So to get to a balanced budget, are you going to cut discretionary spending (education, homeland security, perks for your constituents, etc.) or Defense Spending (even though defense industries are scattered in every State to ensure Congressional votes)?

You know the answer. No and No.

3. Economic data has been very weak and deteriorating; yet this past month, two unbelievable things have happened to make me confused:

A. The Federal Reserve Chairman has been saying for some time that the economy has been slowly improving; and that based on the data, the Federal Reserve stands ready to assist (meaning QE3) if the data shows the economy is slowing further. Yet, two weeks after saying this for the umpteenth time, the Fed surprises the market with potentially the biggest injection of money ever! What about the data? I thought we were improving?

B. The data. This month the data, in contradiction to the Fed action, has been unbelievable: unemployment has dropped, retail sales have jumped significantly higher, housing starts have jumped significantly higher, etc.

We know you have “economic models” to predict the numbers, but the data does not fit the description of the economy provided by the Federal Reserve Chairman prior to injecting money into the banks (QE3). Does this mean the economy is getting worse and the models will reflect the real economy in a month or two or have the models just gone wacky?

Well, I know I’m over the time limit and it’s my opponents turn to talk so I’ll stop.

Bernanke Blowing Bubbles Again

September 14, 2012

Yesterday, Fed Chairman Bernanke announced that the Fed would:


1.. Extend the Zero Interest Rate Policy (ZRIP) until mid 2015

2. Continue the $45 billion per month Twist program (to keep long-term interest rates low)

3. Start buying $40 billion per month of Mortgage Backed Securities until employment improves (does that mean in perpetuity?) He will even add more money if the labor market does not improve.

The market has been expecting this for more than a year. The surprise was that the amount to be purchased was open-ended. That is really kicking the can. Chairman Bernanke also revised his GDP growth number down to 1.7-2. from 1.9-2.4. He must be very nervous because he seems to make downward revisions after each meeting.

Where will all this money go? To the banks of course! They will be able to get damaged bonds off their books at a good price and then use the money to beef up their balance sheets by investing the money in stocks and bonds here and abroad. It may not do much for employment but it should be good for the markets, at least for a while. But sooner or later we will have to pay for it with a deeper recession or inflation.

What went up in price on the announcement? For example: Gold, Silver, Equities, and Oil. What went down? For example: Bond prices and the Dollar.

Oh, Paul Krugman, Nobel-Prize winning economist and professor, again, does not think The Fed is spending enough.

Summer Ends and the Volatility Season Begins

August 20, 2012

As the low summer volume is about to end and the aggressive Presidential campaigns start spending their billions in campaign funds begin; we are about to get some serious volatility over the next six months Maybe sudden sharp drops followed by "clarifications" and short-covering, changing and conflicting poll numbers and then more clarifications again and again.


We are facing a number of serious issues between now and the "State of the Union" speech in late January. For example:

1. The overly optimistic, but constantly being revised downward, GDP, revenues, and profit numbers being forecast for the third and fourth quarters,

2. The debate in Europe (or press releases that levitate the markets until the data is fact checked) about how countries with almost no growth and no way to pay the interest on past debt can increase their debt so they can solve their problems (our economy and markets are correlated with Europe),

3. The end of the "Bush" tax cuts on December 31 which if not extended will increase Government revenues but lower revenues and spending by taxpayers and lower GDP,

4. The debt ceiling (again) will have to be increased by October (a guess) or the government will not be able to pay bills its now obligated to pay (and what about the threat of another credit rating downgrade),

5. The Federal Budget (or some temporary agreement to fund the government) needs to be approved by Fiscal year-end September 30. Even though Congress is obligated to do so, we haven't had a budget in four years, just continuing resolutions,

6. The 3% or $4 trillion dollar cuts the budget (Discretionary and Defense) that are suppose to take effect on January 1 that both sides now claim can't be done in this difficult economic environment (is that the same as "Recovery"). Maybe that's why they kicked the ball into 2013 because there is no willingness to cut anything.

7. The 21 new tax increases and many new requirements of ObamaCare that begin in January. Will they be implemented or rescinded by the election?

That's enough to give you the idea that all of these issues, plus the political rhetoric and the daily polls, will make each day a new adventure. Also, since we have moved from an entrepreneurial to a centrally-planned economy over the years, all we can do is react to what the central planners propose and do.

This increase in volatility with no way to predict the market direction on any given day means we have to look at an investment strategy that will protect our capital during this volatile period; and for more aggressive investors, offer ways to capitalize on this volatility. Call your investment advisor and discuss how to get through this upcoming volatile period.

The Market May Be Saying the Fed Will Move Next Week

July 25, 2012

It looks like the Fed may be ready to move next week (meeting is July 31-August 1) on a new Quantitative Easing Program or QE3 (translation: money printing.) Jon Hilsenrath of the Wall Street Journal mentioned that the Fed may or may not move at their next meeting as the economy has continued to weaken. This "leak" helped move the market up (but still closed down) in the last half-hour yesterday. Today, comments by Steven Roach and others indicate that the Fed will move at the August 1 meeting.


I have been predicting that the Fed would inject more money into the system for some time. It is the only thing they know how to do and they can't escape their Keynesian thought model. However, I thought they would have acted sooner because we haven't solved the problems that created this recession and both parties want to get re-elected.

I don't know if the Fed will move next week or not. But, what you expect the market to do on learning of QE3; it is doing. From this mornings low, equities have rallied to over 100 points, the dollar is down (printing debases the dollar) and gold is up big (reduced buying power and fear of inflation.)

Will this help? Depending on size and pace of printing, etc., it could levitate the market for a short period of time (weeks to months.) But in the long term, it will not work and in fact make our problem of de-leveraging worse (more painful)

Show Me The Money!

July, 19, 2012

According to Chairman Bernanke’s testimony in Congress the other day, he said he is concerned by two major events: The Fiscal Cliff on January 1, 2013 (expiration of the Bush tax cuts and the imposition of new taxes in the health insurance program) and the deteriorating situation in Europe. Oh yea, the economy is “growing” too slowly and employment levels are unacceptable. Also, that the Federal Reserve stands ready to add additional “accommodation” if necessary.

 

Here is the translation: without more money from the government, the economy is headed back into recession. Why?

 

1. We have not solved the problems associated with the b bursting of the financial bubble (bank, housing, consumer debt, etc.)
2. The “solution” (increasing the money supply) we have taken has made matters worse.

• Stimulus wasted
• QE1, QE2, Twist, Zero interest rate policy, etc. causing mal-investment
• Chronic, excessive spending at over $1 trillion per year
• Regulations that don’t make sense and are undefined
• We haven’t even discussed current mal-investments (other bubbles) like education, free healthcare, bloated government and financial system.)

3. Will more money solve our problem? No, but we have been able, through massive insertions of money, to “reduce the pain” of recession by postponing reality; but this only means that it will take longer and the problems will get more severe when we are forced to deal with reality. For example:

 

• We have added, in sovereign debt alone, $9 trillion (nine thousand billion dollars) and we can not even cut one billion from our spending.)
• Our debt is now (before next year’s budget and a new higher debt limit) at 102% of our GDP. That of course is before corporate debt, consumer debt, state and municipal debt, etc.)
• Even more troubling is that our sovereign debt is now at 10% of our revenues (taxes) and 10% is the line that determines risk and no risk. And that’s at our current low interest rates. Therefore, going forward, by definition, U.S. Treasuries will no longer be “risk free;” and you can see what’s happening in Europe. 

Will we solve our economic problems?

 

Yes. But the method and timing are uncertain. In the meantime, we are left with letting the economy slide back into recession (enabling the problems solve themselves) and accepting the pain that goes with it OR adding more paper money and trying to kick the can a little farter down the road. My guess is that the politicians will, when they begin to feel the pain of reelection, show us the money.

 

It is theoretically possible to get a politician to define and articulate a strategy to get our economy back to reality in X number of years. But, if that politician doesn’t show up soon, we will eventually be left with two options: default or very high inflation.

 

Our economy and markets are now unfortunately left to the whims of politicians which mean we have to think differently and adjust our strategies to match reality.

 

Three Big Events Coming In The Next Two Weeks

June 14, 2012

Everyone knows we have lots of headwinds facing the U.S. and the global economies over the course of this year. But, I wanted to comment on three events that could move the markets in the next two weeks.


First is the Greek election on Sunday, the 17th.

The conventional story is that if the far left party, headed by SYRIZA, wins, he will negate the "Memorandum of Understanding" that the Greeks made with the EU in order to get their latest bailout money. If that happens, many feel that Greece would have to voluntarily leave the Euro and go back to their old currency which would be very painful in the short term or the EU would have a reason expel Greece from the Euro. The election is too close to call.

From everything I can find it looks like SYRIZA may modify his view to one of re-negotiation rather than simply tearing up the Memorandum. One reason is that a survey says 80% if Greeks want to stay with the Euro; they just don't want the severe austerity that goes with the agreement. Also, Spain just received a promise of a bailout package without the severe austerity demands placed on Greece. Also, a large number of SYRIZA's supporters are government workers and want to keep getting paid.
Therefore, on Monday morning, the S&P500 could open up much higher or much, much lower. And this is not to mention Egypt with the military decree that the last election was illegal.
Second is the decision of the Federal Reserve on Wednesday, the 20th

The country is disproportionally divided on whether the government should inject more money into the system. Keynesians are demanding additional government spending and money printing. Keynesian-Lite's are demanding tax cuts and defense spending paid for with borrowed money. Net, more spending and more printing of money.

The markets appear to be waiting for the Fed announcement which they believe will be for more printing or QE3. Or at the least, more "Operation Twist" for a few months with QE3 coming soon. If the Fed says they are standing pat, it could disappoint. If the Fed's goal is to keep markets stable or prices stable, they need inflation (QE3 which is money going into banks so they can drive up asset prices) to offset the deflation going on in depressed industries.

Therefore, we could have a much higher market or a much lower market on Wednesday.

Third is the Supreme Court Decision on ObamaCare

The Supreme Court usually announces decisions on Monday's in June before they recess for the summer. This means next Monday or the following Monday. The two big issues I think are the mandate that everyone is required to buy health insurance or pay a fine/tax; and if the court will through out the entire 2,000 some page law altogether.

The result will move the market either way.

I Am Schocked!

June 6, 2012 European politicians have announced that they have found a way to keep the banquet going for a while longer. Isn't that what politicians are supposed to do: keep kicking the can down the road past the next election?) They are in the process of putting together a program to refinance Spain's banks through European guaranteed loans. Not recapitalize the banks but get them refinanced. According to the press reports, Germany will agree to this (it can't be done without German guarantees); and Spain will agree because they will not impose an austerity program on them like they forced on Greece. When is this supposed to happen? After the banks are audited, they expect a package ready by the beginning of July. Will this actually happen? Who knows but there is great pressure on Germany, even Tim Geithner is telling Europe to do something (and it not to pay taxes.) Also, for a small kick down the road and more time, the short-term costs to Germany may be less than the long-term costs. Maybe they can even get help form the U.S. Many Keynesian economists are telling Bernanke to help. Even Steve Liesman of CNBS called for the US to help bail out Europe. The rhetoric is beginning to change here also from "we're done" to more stimulus and money printing. Isn't that what politicians are suppose to do? Yesterday in the Wall Street Journal, Jon Hilsenrath wrote an article about how the Fed may now be ready to be more accommodative (Federal Reserve information is often leaked through Jon). He indicated it could be a short-term extension of the "Twist" program while they wait for more negative economic news or maybe direct purchase of bonds. Timing could be June20 meeting or maybe August depending on how they see the economy performing. Are you shocked?

When Will The Federal Reserve Begin Printing Money?

Not being an insider, I don’t know. However, here are some of the estimates: 1.When the S&P500 gets down to 1150 (currently at 1290) where it was last December. 2.When the 10 year Treasury yield gets down to 1.5% (where it was the last time they intervened.) 3.When we get a series of really bad numbers on the economy (like the Philadelphia Fed report last week.) 4.When Chairman Bernanke “sees” prices decline (i.e., Consumer Price Index) as he fears deflation. 5.When Chairman Bernanks needs to keep the dollar from rising too high (which hurts exports and the recovery) and because he needs to support the Euro to prevent a disaster. 6.When Chairman Bernanke needs to help the European Central Bank flood the financial system with liquidity if/when Greece votes to exit the Euro and austerity.

Are We Headed For A Recession Or Another Money Bounce?

May 16, 2012 As I have been saying for some time now, the U.S. economy is headed toward “another” recession within the next few months, maybe June or July. The only thing that will temporarily stop and reverse this trend is another huge stimulus package or more money printing by the Federal Reserve. Printing and spending more money will not solve our economic problems, it will only make matters worse in the long-term because the money will be gone and the debt will be even higher (Thanks Grandpa!) BUT, it will produce some hopium to lift the economic numbers and the market. This seems to be the politicians’ only solution to the problem. But, even this is getting more difficult to accomplish. In the first three months of this year, over $300 billion was “printed and pumped into the economy” yet GDP only increased a little over $150 billion. There are a lot of reasons for the view described above including: 1.Money Supply. With QE’s done and the “Twist” program about to end, the pace of money coming into the economy has been slowing down for a couple of months. The pace of money injection is as important as the amount and has about six month lag time. 2.Credit. The yield curve (the price of credit over time) is being artificially held down by the Federal Reserve forcing savers and investors to take on more risk to get any yield. However, for the past few weeks, the credit markets have been telling us that an economic slowdown is coming. For, example, the yield on the 10 year Treasury is down to 1.75% and on the other side of the coin, the price of high yield instruments have been selling off (pricing in recession risk.) 3.Economic Indicators. The forty some economic indicators that come out each month have been showing many negatives, regardless of the “Headline Spin” being used to make it sound like things are improving. For example, for the past month, the weekly “Unemployment Claims” have carried headlines stating that the numbers of claims are down from the previous week. Yet, each week, they report that the claims the prior week were adjusted upward resulting in the current week’s claims being less. Net result is claims were up for the month but they were reported down each week. Shouldn’t random adjustment go in each direction? 4.There are also a lot of headwinds to be resolved like the deficit ceiling (estimate we will have to raise it again in October), 2013 budget (September), the “Doc Fix” for Medicare (December), the “Bush Tax Cuts” (December), and lots more. Did I mention it’s an election year? Back to paragraph one. This economy is headed for another recession and the only way politicians know how to change that trajectory is by printing more money. Therefore, I expect to see some form of QE3 or Stimulus soon; maybe at the June Fed meeting.

A Marginal Improvement in Employment? Maybe.

May 7, 20012 April’s Non-Farm Employment Report showed an increase of 115,000 jobs plus an additional 59,000 jobs in revisions for February and March. Unemployment rate dropped to 8.1% (due to reductions in labor force participation.) This is a marginal improvement because it exceeds the estimated number of new people entering the labor force each month. Also, long-term this number is very important; but this data point is a lagging indicator not a leading indicator. The two leading indicators in this report: (1) wages, which were unchanged (negative if inflation included) and (2) hours worked which was unchanged as well at 34.5 hours per week. The net result was a very weak report. This means both political parties will shout that something has to be done. The Keynesian-Left wants the government to borrow even more money for another round of stimulus to “fill the gap” in consumer spending; and then reduce spending sometime in the future. The Keynesian-Right wants the government to borrow even more money to reduce taxes and stimulate supply; and then reduce spending sometime in the future. Do you think the economists or the politicians really know what supply and demand means or how it works? If they did, they would attack the cause rather than the symptom. There are a couple of real concerns however in this jobs report. One is that the model used to seasonally adjust this data has not been adjusted for the warm winter whether. The seasonally adjusted model has now added about 4.9 million jobs (jobs the government expects will materialize in the future) which will be re-adjusted (removed) from the actual numbers later in the year. Hopefully that will happen. The other concern is that we are loosing full-time jobs (-812,000 in April) and replacing them with part-time jobs (+508,000 in April). What kinds of jobs are being created? This trend has been going on for some time now. This may also be a reason that wages are not moving higher. With 90,000 people entering the workforce each month, and an election only months away, this slow jobs growth problem will become very important. Can you say QE3?

Will The Fed Print More Money?

April 12, 2012

This is an important issue right now, especially in this election year. Consensus is mixed, depending on one’s view of the “recovery”, but the market appears to have melted up in anticipation of the Fed injecting more money into the economy. Then, when the minutes of the last Fed meeting were released on March 19th, the consensus of the committee was that the economy was slowly improving but they acknowledged that employment was still a concern. Therefore, additional accommodation (printing money) by the Fed may not be necessary. However, since then, the market has begun to sell off and one reason is its disappointment with the Fed’s position to not inject more money right now. Do you think the Fed really means this? Here are some thoughts from the different sides of this argument.

The Keynesians (mostly Democrats) View

In a recent article in the New York Times, Paul Krugman argued the following:
1. Because the Fed expects low inflation and high unemployment, the Fed should be much more accommodative in order to accelerate the recovery. If we don’t, we will choke off the recovery.
2. The reason we would not be more accommodative is the Republican’s misplaced fear of inflation.
3. But, we can’t worry about inflation; we should be more worried about employment. In fact, inflation of 4-5% would be a good thing. Not a bad thing.

The Keynesian-Lite (mostly Republicans) View

In a recent report written by Brian Wesbury of First Trust, he argued the following:
1. The Fed has finally admitted the economy has improved and took QE3 off the table. There is no need to print additional money.
2. Monetary policy has been accommodative, but monetary policy is not the driving force behind the market, profits are…and profit growth will continue.
3. The Fed will start raising interest rates before its stated date of late 2014. Increasing rates will keep inflation in check.

Capitalists/Austrian Economists View

1. The economy is still in recession as none of our problems have been solved. But, the Fed has already printed too much money and is prolonging the recession with additional injections of money. The only think they have accomplished is unsustainable debt and they are laying a foundation for inflation.
2. We have printed and spent $8.5 trillion dollars in the past four years. This money has raised nominal GDP. That’s because GDP is a mathematical model in which every new dollar created adds (arguably because nominal GDP has risen only $1.4 trillion) a dollar to GDP. But now the money has been spent, we have the debt and real growth has not occurred (8 million jobs lost, 7 million homes in foreclosure, banks under capitalized, interest expenses exceed 10% of income (tax revenues), wages have not kept up with inflation, sovereign, corporate and personal debt, etc.)
3. Now however, the pace of new money creation has slowed for the past two months. Because the money created with credit has been spent, the Fed has to create more money each year than it created in the previous year or the total amount of money supply contracts…. which contracts GDP.
4. Also, Bernanke and the Fed believe we are in a cyclical recession (normal, shallow) versus a systemic recession (major, caused by structural changes.) Therefore, they believe they can fill the spending “gap” with government spending which draws consumers back into the market and ends the recession. This recession is far more serious than a temporary gap in consumer spending.

Conclusion

This recession is far more serious than a temporary gap in consumer spending.
We have below trend growth and stagnant incomes and we have an election year. Do you think the politicians will print more money and kick the can down the road past the election or opt for austerity and a return into recession? I think the answer is they will print more money, but they need “an excuse” to do so (i.e., a bad jobs number or a market sell off or a war or?) because some voters are worried about our ever increasing debt. Therefore, we are now on a path toward more money, more debt or a deeper recession.

The markets are at the top of their range, where do we go from here?

March 21, 2012

Simple question but difficult to answer. Here is the long answer.

I still think that we are getting near a tipping point with both the economy and the markets. The “economy continues to improve” groups are basing their argument on headline numbers. For example,

1. Auto sales are up slightly but inventories are even higher;

2. or an average 200,000 jobs have been created over x months but that is not enough and half the jobs are part-time and for lower wages;

3. Or manufacturing and service indexes are over 50 and therefore show “modest growth,” but are higher inventories good for the economy or just GDP index.

4. Corporate profits are high (decades high levels) and going higher (implies margins will continue to expand), but many indications that margins will contract (rising costs, gasoline hurting consumers, increasing housing foreclosures mean people have to move and pay rent rather than spending their mortgage payment on restaurants and cars, etc.)

5. The warm whether is also a factor being ignored by the Fed’s models.

At the same time, the money the Federal Reserve and deficit spending have pumped into the economy is going into the markets as Bernanke wants to get them animal spirits going; and he is being helped by the media: consumer sentiment is improving and the VIX (volatility or risk measure) is now extremely low (what risk can there be?)

“Darth Vader” on the other hand is looking at the fact that the pace of money supply(the key driver of GDP) has started to contract and that means decline for the GDP by June/July unless there is a new stimulus program or QE3+.

I think the Fed is looking for an “excuse” to print more money but it can’t look like a political move so he needs some economic data to point to in order to pull the trigger. This could be some bad economic numbers or a market correction along with a correction in gold and silver. Or it could be done through stimulus as we prepare for to engage in another war.

Net/Net: The economy remains in recession and looks to stay there for some time because we have not addressed any of the issues that brought us into this recession or are keeping us there (spending, debt, central planning, printing money, government interference in the economy and markets, etc. etc.

But, the $8 trillion dollars pumped into the economy has helped GDP’s and increased assets. This is what politicians (including Fed Reserve politicians) do. It seems to be the only thing they know how to do. Therefore, I expect another round of stimulus or money printing in time to help the elections and before the new debate on the debt limit ceiling which will likely be reached by October.

Investments must be flexible (risk on, risk off) because the exact shape and timing of the markets are unknown; and tradable (for protection and opportunities) until the longer trend becomes known.

Net/Net: The short answer is that the market is at the top of its range and can only be held there by more action from the government.

Is It Decision Time for the 2012 Economy?

The media has been reporting for some time, based on "expert" opinions, that we are in a recovery and that the economy is slowly getting better. There are some data points that are getting better. Afterall, we should get some nominal improvement after the government spent about $10 trillion in the last three years (40% of it borrowed) and the Federal Reserve printed another $3 trillion over the past four years. But, the problem is that it's only temporary. The improvement only lasts as long as the printing presses are running. The net is that the market is being held up by printing money but the economy itself is not improving much.

Now however, we are running out of previously printed money. Quantitative Easing (QE1 and QE2) and the Feds "Twist Program" are winding down. So going forward, we can't get an increase in nominal GDP growth. Therefore, GDP will now start to decline. For example, Goldman Sachs revised its estimate of GDP in the first quarter down twice lat Friday and Bank of America is now at 1.8% for the first quarter. We must print more money to get an increase in GDP.

Yes, both political parties know this and the Federal Reserve knows this as well. But, with current debt at close to $16 trillion, some people are saying no to more debt. Therefore, the government needs to "prove" we need more money printing. After all, elections will be here soon. So, the Federal Reserve needs some bad numbers now to justify printing more money. I wonder about Friday's jobs number. Maybe if gold and silver dropped in value, it would show that debasing the dollar by printing money wasn't the reason for its rise in value. Or maybe a quick hit to the stock market would generate enough fear to do the trick. And, oil needs to come down in price because you can't start a war with oil over $100 per barrel. Or?

The net is this; we could be at a tipping point. Either we side back into recession or we print more money and "jump start" the economy, again.

Sovereign Bond Risks to Increase Significantly

February 21, 2012

If you remember, we were frightened when the U.S. Government threw out two hundred years of settled law when they arbitrarily threw out the superior claims of General Motors' bondholders in favor of the subordinated claims of the shareholders and unions. But, we have since dismissed this incident as being just against one company; and besides it was politically expedient.

However, we did the exact opposite in the financial crisis when we saved the bondholders with public funds. Again, it was politically expedient.

Saturday, the European Central Bank (ECB) did something they may regret later. They exchanged their existing Greek bonds for "New Greek" bonds that are not subject to the "collective action clause" (which allows a supermajority of bondholders to agree to a debt restructuring.) Now, under the new terms, the ECB has first claim to Greek assets over all other bondholders. They did this without the other bondholders consent and without objection from other European nations.

In other words, the ECB can now retroactively change the terms of any bond contract. For example, who has the superior claims against assets, the interest rates, the maturities, etc. at any time it's to their advantage and without bondholder acceptance. No rule of law. No judicial appeal.

Bond buyers will now have to reassess the current value of European bonds for this new risk and then evaluated them against U.S. Treasuries where we have had the rule of law. This increased risk should have an impact on Europe and on our markets.

The Drums Of War

February 20, 20012

Everyday there are additional stories about the dangers in the Middle-East and the threats posed by Iran. The next day, an even louder response. Then, came the sanctions on Iran and now the U.S. and NATO have began to tighten those sanctions. From an economic point of view, Iran gets 60% of its income from the sale of oil. These sanctions now include restrictions on who can buy Iran's oil in an effort to reduce their revenues and at the same time, the U.S. has put a hold on Iran's sovereign bank accounts. Logic tells you that if the sanctions work and Iran sees the "situation" as hopeless, they have nothing left to do but surrender or strike out. We know they have recently threatened to close the Strait of Hormuz.

We also know there is a rule of thumb that says currency wars (which are going on world wide now) lead to trade wars (more and more talk about tariffs, etc.) and trade wars eventually lead to real wars.

Therefore, if sanctions against Iran become crippling and they close the straits of hormuz for even five days, the price of oil would significantly increase and if something more severe would happen like the disruption of oil for 30 days, oil could jump to $200 or so. Who knows how high it could go.

Headlines Can Be Deceiving

Today, the January Jobs Report indicated that the economy created 243,000 jobs in January and the unemployment rate dropped to 8.3%. That sounds good and most of the “experts” were screaming that this more proof that the economy has turned around and job growth will continue. What they didn’t do is look beyond the headline.

First, I was startled when I heard the headline numbers. Here is the context behind the numbers. Last week, Chairman Bernanke said the economy was soft and lowered his GDP growth estimate, extended the zero interest rate program through 2014 and implied that he was ready to intervene with more money creation if necessary. That doesn’t sound like the environment for “surging” new job growth.

So here is some information behind the headline.

1.A record 1.2 million people fall out of the labor force (these are people who are no longer looking for a job.)

2.This means that the percent of the population that would like to work dropped to 63.7%. The long-term, historic percent is 65.8%. This is important because this is the number they use to determine the unemployment rate. This is 5 million people less looking for work than is normal; and with 5 million less people you get a much lower unemployment rate. And baby boomers are not retiring like many assume, In fact, their participation rate in increasing.

3.Part-time workers increased by 699,000 and full time jobs increased by 80,000 jobs. So about 10 percent of jobs were full time.

I am not saying there is a conspiracy to improve the numbers. It is the way the math model works. But it does demonstrate that you must look beyond the headlines to get the real story.

Why Is The Market So Optimistic? What’s Changed?

It’s not the economy. Not much has changed there except for a few of the many antidotal data points that are published each month. The expert’s points to three or four of the 30 reports published every month and conclude that they signal that the economy is recovering. Most don’t look at the context surrounding the data point so they don’t know what it means (do you think the guy writing headlines knows how the CPI index is adjusted for quality improvements verses price increases) or even if ”that data point” can be used to forecast the future.

There are two things that have changed. One, we continue to pile up debt (now exceeding 5 times our revenues) at a rate of $4 billion per day increasing the probability that we will have to eventually default on our sovereign debt. Two, the Federal Reserve continues to print money in increasing amounts and in many different ways like helping the European Central Banks with liquidity, or running a “Twist” program here to bring down long term rates, or the Zero Interest Rate Program (ZIRP) to help the banks and hurt savers (and force them into higher risk investment to earn any return on their investment.)

Then, yesterday, Chairman Bernanke announced that he intends to keep ZIRP in place through most if not all of 2014. Remember, both political parties were angry with Chairman Greenspan for the housing bubble because he held interest rates at one percent for a year. Bernanke intends to hold rates at zero for four years! And then, just to make things worse, he said he would be willing to “be more accommodative or in English, print more money) if the economy gets worse. Oh, by the way, he revised his estimate of GDP growth down another quarter percent.

Money supply data shows that the Federal Reserve has continued to increase the money supply and has increased the pace in the past month. In spite of what Bernanke says, this is money printing (QE3) pure and simple. Since we know that increasing money supply is how you increase GDP, the markets are pricing in the increased money supply.

We Must Change The Way We Look At The Economy

Until WWI, America was a booming Free Market economy. By 1890, American manufacturing output surpassed that of Great Britain. In 1913, Henry Ford paid his employees $5 per day which equates to $10,000 per month in today’s inflated money.

America thrived because Free Markets are driven by entrepreneurs making decisions based on the knowledge they have, how they viewed the future and their willingness to take risk. Unavoidably however, not every economic decision can be correct; therefore Free Market business cycles are prone to some excesses and recessions. Without government interference, these shallow business cycles were generally short-lived and produced tremendous economic growth.

Today’s economy and markets are fundamentally different than those of the past. Expanding government interference in the economy has slowly changed our economy from a market based, entrepreneurial economy to one that is Centrally Planned. America’s current economy is driven by politicians and their friends: favored corporations and their lobbyists who are often referred to as “capitalists.” One result of this transformation from a Free Economy to a Centrally Planned economy is that short, self-correcting cycles have evolved into volatile bubbles and busts.

The individual, economic decisions of 320 million citizens that drove the Free Market economy has been supplanted by an elite gang of politicians and their favored corporations. The economic “experts, ” the pundits and the media prove this every day with their constant calls for the government “to do something” - to solve the debt crisis, to create jobs, to invest in green energy, to fix the housing problem. The American economy is being transformed from an entrepreneurial-based, manufacturing economy to a financially based services economy dominated by the political class and their favored, financial institutions.

Central Planning is bringing our economy to the edge of disaster

Markets are no longer focused on companies and their future prospects, but on media headlines made by our Central Planners. Yet it has been proved over and over that central planning does not work no matter how much the politicians want to help. It is impossible for a few elite politicians to know the wants, needs and preferences of 320 million people, let alone the complexities of a $60 trillion dollar global economic system.

Central planners make decisions based on political concerns and personal agendas. As a result, they interfere with the economy based upon political expediency, not fundamental economic reasoning. Their political concerns create a paradigm of decisions that are naturally shortsighted, and they generally get fiscal and monetary policy wrong. The hubris and power of the Central planners means they can never admit they were wrong, which leads to more interference, more short-sighted decisions and more damaging fiscal and monetary policy decisions. The Central planners are leading us to the edge of disaster.

The Yellowstone National Park fire

The Yellowstone fire of 1988 provides an excellent analogy of what has been going on since WWI. Yellowstone National Park was created in 1882 and is managed by The National Park Service in Washington, D.C. There are about 35 forest fires each year caused by lighting and about 6-10 fires caused by man.

Until the mid-1960’s, any fire was thought to be detrimental to the park and forests. Fire Management Policy was to suppress all fires as quickly as possible. The beneficial, ecological role of fires was ignored (fires cleaned out the understory and dead plant matter, helped fertilize the soil and allowed new tree species and plants to grow.) Doesn’t this sound like the role of recessions?

In the late 1960’s, Washington D.C. slowly began to see the benefits of the fires and began to change its policy to allow some fires to burn out. But, by this time, the forest was very mature and a significant fire hazard. A crisis was imminent.

In 1988, lightning started a fire on a very dry June day. It quickly grew out of control and soon the wind spread to different parts of the forest. The fire burned for months even though 9,000 fire fighters and 4,000 military personal were used. The fire was eventually extinguished in late fall by rains and snow. About 73,000 acres or 36% of the park was affected and fighting it cost $220 million in today’s dollars.

Our centrally planned economy may be headed for the same kind of fate.

A few central planners can never replace the value of millions of entrepreneurs. Government’s “management plan” of trying to stimulate every little dip in consumer spending with borrowed money has led us to an unsustainable debt level and pending crisis. Yet, the government refuses to face this issue and others.

Studies have shown that when sovereign debt exceeds 5x revenues or when interest payments exceed 10% of revenues, repayment of the debt goes from almost no risk to risk. Once there is a perception of risk, it becomes more difficult to raise additional money. Generally, deficit spending continues, debt mounts and interest rates begin to rise. For example, U.S. 10-year bonds carry an interest rate of 1.98% - at this time, Italy’s 10-year bond as an interest rate of 7% (and the rate increased from 4% to 7% in just a few days), Greece’s 10-year bonds have an interest rate of 37%. Untreated, interest expenses will eventually consumes all revenues. Then, the sovereign is left with three choices: severe austerity, default on the debt or default by inflation.