“Print ‘Till You Drop” Update

In Scenario One: “Print ‘Till You Drop” I estimated the market would continue to drop until monetary policy (the Federal Reserve printing money) or fiscal policy (Government spending and borrowing money) began to re-inflate the economy and consequently the markets. The timing of the turnaround would be dependent on the “pain” felt by investors and politicians. My estimate was +/- Labor Day because it takes time to implement these programs and the election cycle begins to heat up.

Also, my assumption was a new stimulus program would be initiated (and one was introduced by President Obama as a “Jobs Program” for $445 billion) and a new Quantitative Easing (QE3) program from the Federal Reserve. The political mood is against more stimuli at the moment, but the Republicans can’t resist tax cuts so I assumed about $300 or $350 billion would get through the Congress. Net/Net: we basically have two options: Re-inflate the economy and markets (print ‘till you drop) or revert to a capitalist system (small government and a privately run economy.)

Since there is little chance we will go back to a capitalist system, my assumption was that the government would be “accommodative.” This assumption appeared to be correct when the debt ceiling was raised with almost no cut in spending until 2013. Then, a month ago, Fed Chairman Bernanke extended the zero interest rate policy (ZIRP) through at least mid-2013 and a statement that the Fed would remain “accommodative.” He re-iterated that statement when he was in Minneapolis a few weeks ago.

In the meantime, it was leaked that the Fed would, at minimum, initiate a “Twist” program. This program would sell about $400 billion of short-term treasuries and buy $400 billion of long-term treasuries in order to drive down long-term interest rates and help the housing industry refinance. This program would not increase the money supply (sell 400, buy 400) so it would not help re-inflate GDP or the markets. In fact, Since QE2 ended, money supply would actually contract because he did not replace the $600 billion in new money he printed for QE2. As you know, contraction takes away from GDP and thus the markets.

By the way, by itself, “Twist” will not help the housing situation either. It will also cause the yield curve to flatten (not much difference in interest rates between two year bonds and 30 year bonds) which takes the profits out of lending.

Many thought, me included, that the Fed would “surprise” the markets with additional easing or money printing. For example, stop paying banks interest for excess reserves held at the Fed which would force the banks back into the lending business. Also, to push additional money into the financial system to cause inflation (help GDP, help the markets, reduce value of the dollar to help with exports.)

On Wednesday, the surprise was that the Fed did not agree to create more money. Evidently, we have not reached their pain threshold yet. However, within hours of the Fed announcement, European markets began to fall apart again. World GDP growth rates were reduced, including the U.S. So, the question becomes: is this enough pain or do we have to wait until the next Fed meeting in November? Or is the political will to spend more money just not there?

The Lack Of Consumer Spending Is The Problem, Right?

Everyone knows that what is causing the recession is the “gap” in consumer spending, Right? That is the explanation according to Keynesian economics and that’s what we have been told. So after spending trillions of dollars trying to fill the consumer spending “gap” and creating $15 trillion in debt; we have been told (Paul Krugman, et.al.) that we just didn’t spend enough.

Great, so we are now about to spend some more on: 1, a new “jobs” bill that will do nothing but add to the debt and accomplish nothing long-term and 2, a new Quantitative Easing Program ( QE3 or money printing) to help the banks and hurt savers.

Printing money does levitate the market, especially when the new printed money goes to banks who can then invest it in the capital markets and in higher paying foreign investments. BUT, consumer spending is not our problem. Here are some numbers from the Bureau of Labor Statistics (dollars in trillions) that prove the point.

Year....................2006 2007 2008 2009 2010
Government
Expenditures...........$4.14 $4.43 $4.73 $4.99 $5.26

Personal
Consumption............$9.52 $10.00 $9.74 $10.34 $10.45

Private Fixed
Investment
(Business
Spending)..............$2.26 $2.26 $2.12 $1.70 $1.72

This is telling us that the real problem is Business Investment. It is down by $539 billion or 23% from the peak in 2007; and running at about 76% of the 2006 level.

Isn’t this the real question: Why are businesses unwilling to invest and grow? Or is all the investment overseas where the business climate is more favorable?

More Hopium On The Way

Our down trending economy and markets may have begun to levitate again with Chairman Bernanke’s Jackson Hole speech last week when he announced the Fed would keep interest rates at zero for two more years (that would be 4.5 years total.) I believe this is just the beginning of “QE3” (generally defined as more money printing.)

Because there is some opposition to more stimulus and money printing (including three of the Federal Reserve’s Presidents and members of Congress,) the Government and the Federal Reserve have to “justify” more spending. In other words, there has to be enough “pain” to justify more spending and interfering with the economy. I believe we will get more fiscal stimulus and more money printing because we have, over the years, turned our economy (and education, health insurance, parenting, retirement, etc. etc. over to the government) and stimulus and money printing are the only way they know how to fix things. Besides, there is an election coming soon and fixing will take time.

There are two data points coming this week that may give the government the “justification” they need. One is the ISM-Manufacturing Report on Thursday. I suspect it will be more negative than expected. The second is the jobs report on Friday. I think the consensus is for about 75,000 to 100,000 jobs. However, the data over the past month is so negative that we may see a much smaller number and even a negative number for August or September. A negative number will defiantly get attention.

These events will be followed up by President Obama’s speech on September 5th when he will tell us what his “plan” is for restoring the economy and creating jobs. I believe it will be a bigger, more expensive program than we have had to date. It will have to get through Congress, but did I mention an election is coming soon.

Also, on September 21st Chairman Bernanke will announce the decisions made by the Federal Reserve Board. If the data is bad enough, we should get QE3 almost immediately. If the data is not bad enough, we may have to wait. But we should not have to wait very long as the economy is sliding further into recession.

In summary, we may get some bad news with the ISM-Manufacturing Report and the August Jobs Report which would negatively impact the market. But, that would be immediately followed up by the President’s new stimulus plan and the Federal Reserves’ money printing plan. This hopium will levitate the market, if big enough, until +/- next Labor Day. Another short-term “fix” and a worsening long-term problem.

Are You Ready For Labor Day?

A lot has happened over the past week or so. I just want to cover the Federal Reserve meeting today. Fed Chairman Bernanke stated after the meeting that we are basically in a recession (my interpretation) that will last for some time; and that he will hold interest rates down until at least mid-2013. This is the normal Keynesian and Keynesian-Lite reaction to a “consumer spending gap” (a reduction in consumer spending.). Fiscal and monetary policy has been doing this (low rates and printing money) for several years now and it is not working very well.

We know that increasing the money supply increases the GDP, but maybe low interest rates and printing money are not our problem and in fact, may be prolonging our problem. However, I think the Fed believes we are still stuck in a “liquidity trap” (over simplified: I (individual, bank, company) have some money and I could borrow more, but I don’t want to spend it or buy on time or invest it because I don’t know what the future holds and if I will be able to pay it back in this uncertain economy.)

The Fed believes, to get out of this liquidity trap, they need to continue to keep rates low and flood the economy with new money which will encourage people to spend and invest. Many think this might be difficult to do now considering the recent debt debate. But this is all the Fed and the government know how to do. They can’t create jobs or fix the housing foreclosure problem or expand free trade agreements, etc. Besides, that’s what a lot of people (like Paul Krugman, et. al.) are demanding. They want the government to do something”.

Now we have a second quarter revision to GDP on August 26th. I think GDP will be revised down from 1.3% to under 1% and maybe down to as little as 0.5%. Since we are obsessed with GDP that is a problem. Two quarters under 1% growth when we need 3% growth to effect jobs growth and unemployment.

Then we have another Fed meeting on August 29th. I expect Chairman Bernanke to announce that additional help (accommodation) will be coming soon. Then throw in the fact t that Congress gets back to “work” after Labor Day and the Presidential Election season is underway.

Therefore, my assumption of Scenario One (Print Until You Drop) is that the economy may not turn up but GDP (the arithmetic model we call the economy) will turn up on new fiscal and monetary initiatives. This will then “lead” the market higher.

There are a lot of implications to this scenario on the upside and the downside for both equities and income securities. Start now to position yourself for what is coming.

We Again Kicked the Can, But the Road is Now Going Down Hill

The “Debt Deal” will likely pass the House and Senate today. It does not reduce the budget or spending very much. Here’s why. The base line or assumption is that the budget will grow about 7% every year (that means a 7% increase is priced in.) So, if the 2011 budget is 3.6 trillion, next year the budget will start out at $3.6 plus $250 billion or $3.85 trillion (assuming no more wars, etc.)

Therefore, in 2013 when the debt ceiling is reached again, the deficit will be $16.6 trillion rather than the $14.2 we have today; and the budget for 2014 will start at $4.1 trillion. Unless we have a national discussion about why we are spending this much money and reach a national consensus, we will continue to let politicians keep spending and monetizing our debt. If you create enough inflation to make previous debts meaningless, is that a default?

At the same time, the global economy, at a minimum, is contracting or slowing down. Therefore, the euphoria that passing the debt ceiling brings will be very short lived. We will have to immediately focus on the economy again and jobs. And there seems to be only one thing the government knows how to do, spend money and pass regulations. Also, it is only 15 months until election so stimulus and QE3 will have to be set up and implemented quickly.

Unfortunately, what we really need is for the government to get out of the way.

Moody's Has It Absolutely Wrong

July 18, 2011

There will be a market reaction to passing or not passing the debt limit. But it is time to start thinking about this problem as adults rather than as political party advocates. Moody’s comments the past few days are a prime example.

Moody’s, the credit agency has stated they are likely to downgrade America’s AAA credit rating if the debt limit is not raised.

Today, Moody’s stated that America should get rid of the debt limit ceiling altogether because it gives them a reason to downgrade our credit rating. This is not only illogical; it’s symptomatic of the way politicians, economists and pundits think. They almost always attack the symptom rather than the cause.

What Moody’s should be saying is that the Congress needs to pass a law that forces politicians to reduce the debit ceiling by some percent every year until our budget is balanced. Our problem is not the current debt ceiling. Our problem is that our budget is not balanced and on an unsustainable path upward.

There are two major reasons we spend too much.

One, the party out of office attacks the party in office for spending too much and the party in power defends the spending. When election results change, so do the positions of the parties. Congress has raised the debt ceiling 140 times since it was enacted in 1917.

By the way, the debt ceiling was created by President Wilson in order to pacify the opposition that he would not spend too much on WWI.

Two, we refuse to debate the cause of our problems. We only debate the amount of money we will spend on the symptom. For example:
1.Why does America with 5% of the world’s population spend about as much as the rest of the world does on defense? Is America responsible for most of the world? If it’s to protect democracy, why doesn’t Switzerland spend more?
2.Why hasn’t poverty been eliminated after trillions have been spent on the poor? Is poverty simply a percent of the population? Are the government and the population an enabler? Is our education system failing us? Etc. etc.
3.Why do we worry about the consumer price index (CPI)? It is only a symptom. Inflation is not a manipulated, mathematical index; it’s the increase in money supply. Should we be increasing the money supply?

I could give you a thousand examples but I think you got the idea. We need to change the way we think. Once we identify the real cause of the problem, we should be able to get consensus on how much to spend solving the problem.

By the way, America has defaulted on our debt five times starting in 1776. Also, the Federal Reserve can buy bonds to fund the government forever and never have to default on the “Public” debt (public debt is what we are talking about.)

Update on Scenario One

July 8, 2011

Scenario One still remains the most probable of my four scenarios. However, if the government or the Central Bank deviates from the “expected” course (from a capitalist point of view) other scenarios might become more probable.

Also, here are some assumptions to consider:

1. The following chart uses the S&P500 index to illustrate this scenario because it is easy to visualize.
2. My assumption is that money supply drives the economy or GDP (and there is a lag time involved here.) Increasing GDP drives business revenues and profits which then drive stock prices.
3. Money supply will slow up beginning in June but will expand when re-election fears really kick in and new “government help” adds stimulus (money creation weather it’s spending or tax reductions unless paid for) to drive up GDP in time to help with re-elections.
4. Serious spending cuts will be postponed until after the election.

Following is a brief description of each point on the chart.


Point 1. Housing bubble bursts and banks become insolvent. The government decides to save the banks by using taxpayer money to “keep them solvent” rather than demanding that the banks try to convert their bonds into equity. Recession is underway.


Point 2. March 2010. The massive increase in money supply which artificially and temporarily increases GDP begins, but results in malinvestments or bubbles. For example:
a. Interest rates reduced to zero and held there
b. Stimulus Programs begin (over $800 billion in stimulus spending and unpaid for tax cuts) plus $1.5 trillion in deficit spending,
c. Mark-to –Market accounting rules revised (allowing banks to increase the ”value” of their mortgage bonds to boost their equity and reserve requirements,
d. Central Bank buys “toxic bonds” from the 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 ends up in foreign banks)
f. Money supply increases at double digit rates for 28 of last 29 months (see assumption 2 above.)


Point 3. May 2011. There is a “short-term” stock market top and correction due to anticipated contraction of the pace of money supply and other headwinds including slowing global growth and debt problems. For example:
a. Stimulus ending in June
b. QE2 ending in June (a and b both will contract money supply which will reduce GDP)
c. Debt ceiling “argument” (raise limit by $2-3 trillion and get more fiscal stimulus or austerity) deadline by August 2
d. Reductions in U.S. GDP (Central Bank reduces growth rate in June) and Global GDP rates
e. Increasing inflation rates (headline and core)
f. Housing still a big problem
g. Unemployment slowly getting worse
h. Earnings (Qr 2) in July should be at or near expectations but analysts are already cutting earnings for second half of 2011. It will be a negative for the markets if companies do not confirm current growth rates for second half.

Economy and markets will become more volatile and trend lower until the government “solves” the problems with more money creation, which is what I expect. Or some kind of austerity program including reduced spending is put in place, which I do not expect. However, if austerity happens, my Scenario Two (continued decrease in economy and markets) would come into play.


Point 4. Labor Day or possibly sooner (for example by the August debt ceiling limit) depending on our central planners (government and the Central Bank) the money supply will again increase raising GDP (with a lag) and then revenues, profits and markets. This up turn will last longer (with corrections along the way.)
a. My guess, debt limit increased with promise to cut spending starting in 2013 (after next elections)
b. As economy drifts lower, the pressure will be on 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.

Point 5. Top of Bubble (Sept-Dec 2012 +/-) caused by the huge increase in money supply added over the years and the malinvestments that have occurred as a result of this increased money supply. This bust will cause a very deep recession illustrated by the S&P500 going back down to 600-650 area.

Point 6.January 2015. Long period of stagflation with low, real GDP growth rates of 1-2% and high interest rates due to inflation.