“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.

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

What's Next For The Market?

Technically, the market is at an inflection point. According to the Dow Theorists, if the Dow breaks 11,823.7 if would signal a correction and even put the market into another bear market. While technical analysis can be correct sometimes, it can also be incorrect sometimes. If it always worked, you could buy the right algorithm, kick back and relax. But, on the other hand, many traders follow the Dow Theory and that alone could move the market for a while.

We do know that the markets are levitated due to government spending and require additional government spending to keep going. So far, talking about cutting government spending is just talk; nothing significant has actually happened. I suspect cuts, if any, will be minor (less than the $1.5 trillion needed to get us a balanced budget.) Therefore, for the moment, I assume overspending and quantitative easing will continue, maybe for years.

also, Fed Chairman Bernanke has the stock market targeted as one of him main objectives. He wants the market to go higher so “animal spirits or greed” will kick in and take over so “real” consumer spending can take place. Therefore, If the market should sell off to 10,000 +/- (about a 15% drop), I think the government will intervene with both stimulus and more quantitative easing (printing money.) After all, it’s only 19 months to the next election…and voter pain will not be tolerated.

Of Course There Is Inflation. Why Haven’t We Seen It?

Every month we get an inflation report. We know gas prices have almost doubled in the past two years and food prices have risen significantly, but according to Fed Chairman Bernanke, we are not seeing any significant inflation. What gives? Why is the government reporting such low inflation numbers?

One reason is the way inflation numbers are reported and the way information is played out in the media. For example, inflation for January was +0.4% and +1.6% year-over-year. First of all, it was just “slightly” higher than expected. OK, it doesn’t sound that bad I guess. But what if it would be reported that + 0.4% annualized is +4.8%. Or that over the past year, inflation has risen steadily from a year ago. Or that inflation has risen 26.5 % since 2000 or 164.1% since 1980. In other words, there is not much context to the report and therefore, it is minimized.

Another reason is that the media is obsessed with speed rather than content so rather than a discussion about inflation or its content, they will simply move on to new information tomorrow. Besides, they think everyone is bored any way once they have heard the number.

Another reason is the way inflation moves through the economy. In the early stages of inflation, it generally rises slowly because the numbers are small in the beginning and people do not think that inflation is here to stay so why worry. If it persists, people begin to change their minds. Once they think inflation is here and growing, people begin to react and it begins to rise more rapidly. Since it’s a compounded percent, the longer it goes, the faster it rises.

We have an unusual situation also, The money supply has been increased dramatically (the cause of inflation) but many people including many economists and the Federal Reserve have been or are worried about deflation (definition is money supply contracting) because of lower sales, lower prices in some cases and consumers not spending as they did in 2007. Never mind that consumers haven’t de-leveraged themselves yet from historic levels in 2007.)

Also, the huge increase in money supply has gone to the banks for the most part. They do not need borrowers to make money. They have been putting the money into assets (bonds, stocks, etc.) and investing overseas. We do not count a rising stock market or heavy buying of bonds (which drives interest rates down) as inflation. Yet that is what is happening. So it appears that we are creating an asset bubble at this time, just different than the tech bubble or housing bubble.

We are also exporting much of our inflation to the Chinese: exchanging our higher cost of production for their low cost imports.

One last reason is the huge Federal debt. Imagine what “investments” could be made by the private sector if we didn’t have to pay hundreds of billions of dollars in interest to foreign countries.

That’s some of the reasons we are not “seeing” inflation. We are not looking for it. But it is here and it will be rising throughout the year.

Why Would the Market Shrug Off a Bad Jobs Report?

One reason could be statistics. There was an alarming plunge in the number of people in the labor market. People drop out for many reasons including going back to school, retired, have given up looking for a job, etc. So, in spite of only creating a net of 35,000 jobs last month, the unemployment rate dropped from 9.4 percent to 9.0 percent. That number sure sounds better.

Another reason might be conflicting surveys. The 35,000 jobs created is from the Payroll Survey which is a survey sent to businesses. This survey is where the government gets the number of jobs created which is reported each month. By the way, the margin of error here is 100,000 jobs. The other survey is the household survey which is a telephone survey. This survey is used to determine the percent of people employed/unemployed. This survey showed a jump in employment of 598,000 jobs which measured against a reduced labor force number resulted in a reduction in unemployment to 9.0 percent.

There are a lot of other statistics that could be analyzed, but the most compelling for me is the amount of new money being pumped into the economy by the Federal Reserve: over $100 billion per month and yet GDP is only rising (or “growing”) by about $40 billion per month. Where this money is going will be the subject of another post. But, this money is levitating the economy and Mr. Bernanke said in testimony last week that until the jobs situation turns around (not sure of his definition but it’s not 35,000 jobs per month) the Fed is going to continue to pump money into the economy. If so, GDP rises which filters into the capital markets. So, what’s a bad number or two?

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.

Some ideas to think about as we head into 2010

We all have ideas about what 2010 will bring. I have made a list of some ideas, some thoughts, and some possibilities that I think might happen in 2010. But rather than guess at where the S&P 500 will end up or how much analysts will trim their earnings estimates; I thought I would come up wit a list of things that could make 2010 better or worse than I envision now. But I also wanted possibilities that would make people think about key elements of the economy as we move through the year. Here is the list.

1.Unemployment will not get much better and could get worse in 2010 because consumers are now into saving and debt reduction rather than spending; and companies key their inventories and expansion off consumer demand.

2.Dollar could increase in value early in the year due to global uncertainties (risks) and what looks like an improving U.S. economy and then fade later in the year.

3.The number of “Tea Party” people will continue to grow and will shape the look of the Republican candidates in the 2010 primaries.

4.More burdensome and anti-competitive regulations will come out of Congress that will prove to be roadblocks to recovery.

5.Concerns about when the Fed and Bernanke will raise interest rates will become mute because the market will raise rates months before the Fed and Bernanke decide it is time to raise rates.

6.The central Bank will hold interest rates low and continue to print money causing the next bubble because of malinvestments.

7.Residential housing will get worse in 2010 due to millions more foreclosures and more “toxic assets” put on bank balance sheets. Commercial real estate will continue to decline into 2011 because of the need to refinance “underwater” properties. However, new investors with assets will begin to buy up these cheap properties.

8.Banks will have to build assets to cover the toxic assets they currently have on the books and to cover the new toxic assets to come in 2010 and 2011. Therefore, bank lending will remain tight (and credit worthy borrowers scarce.)

9.Corporate winners and losers (consumers and tax payers have already lost) in the health “care” legislation will begin to become apparent in 2010 and the health care CEO’s and Unions who made deals with the administration will be surprised when they find that their negotiated “deals” will not be honored by the government.

10.Congress will pass another stimulus package to again help create jobs. It will be large, but it will be passed in smaller packages so they can get the spending bills passed without attracting too much attention or outrage.

11.Climate change hysteria will begin to abate during 2010 and Congress will begin to work on a realistic energy plan that we have been waiting and paying for since 1975.

12.Corporate revenues will continue to be elusive so companies that can raise money (with low interest bonds) will buy revenues and earnings with more mergers and acquisitions.

13.Government debt levels, already very high, will get much higher and the Federal Reserve is funding this debt with short-term bonds. Therefore, the Fed will be reluctant to raise interest rates. Imagine a 50% increase in rates (or from just 0.25% to 0.5%) would due to your “costs” when you are already paying hundreds of billions of dollars in interest.

14.This is certainly a minority opinion, but corporate earnings for 2010 are too optimistic and will be revised downward beginning with the second quarter numbers.

15.New investment areas will emerge because where you have buyers you have sellers and vice versa.

Is that enough or have I missed some important ones. If you have some others that should be added, please e-mail me your idea.

If we could just spend more on interest, we could really stimulate GDP growth

This may not sound right, but give me a second and I’ll show you that this statement is true.

The economy, as defined by most politicians and economists, is a mathematical model called Gross Domestic Product or GDP. This model is based on consumption (spending by consumers, businesses and the government.) rather than wealth building or production. So every dollar spent is a dollar of GDP and every new dollar spent is GDP growth.

Now, if you are in Congress or the President, you could catch on to this real fast. The more you spend, the more GDP goes up and the better your chances for reelection. But it gets even better.

But, we have one speed bump to get over first. To spend a dollar you have to produce a dollar. But the government doesn’t produce anything so it has no money to spend. No problem, it just has to get its dollars from somewhere else.

The government has to take a dollar from producers in order to spend a dollar; or it has to borrow the money with interest from someone else. It doesn’t matter where the dollar came from in the GDP model because every additional dollar the government spends is counted as an increase in economic growth (GDP.)

Now, if the government takes a dollar in taxes from a producer to spend. You could argue that the net is the same; you subtract a dollar from the economy in taxes and then spend that dollar. This could hurt down the road when you have to increase taxes to pay for the dollars you are spending now; but who cares. Many think they will be out of office by then.

You would think tax payers would catch on to this, but remember you elected them because they were clever and great communicators. So they just change the meaning of the word spending to investment and everyone is happy. Long-term you try to convince tax payers that you are only doing this because the government can spend dollars more wisely than the producer or because the government can buy something the producer cannot.

Wait. I’m not done. Here is the BINGO. You borrow lots of the money because if you pay-as-you-go, tax payers could catch on. And you get to pay huge interest payments on the borrowed money—you got it. Every new dollar paid is an increase in GDP.

Now, think of the GDP growth we are going to get when our deficits go up by 10 trillion or more over the next few years. PLUS, if interest rates rise significantly because of all the debt, BINGO –even more GDP growth.

If you think this is a sane approach to our economy, do nothing. If not, support politicians who are sane.

Market Rising Faster Than Economy: Five Reasons Why

The market has significantly outperformed the economy recently. It seems confusing because of all the headwinds making economic recovery so difficult. For example: housing and commercial real estate continuing to decline, an over-levered consumer, growing unemployment, etc. However, the market does not seem to be concerned about these headwinds (at this time) so what are traders and investors using to bid up this market? You see and read a lot about the recession being over or that we’ve avoided a depression or consumer attitudes are improving etc. But it appears there are five major reasons the market is outpacing the growth of the real economy.

1. The “economy” is assembled and dissected as a Statistical Model

Remember, most people see the market through the lens of the conventional, statistical model of Gross National Product (GDP.) This model looks at the economy from a consumption point of view: a dollar spent, no matter who spends it, represents a dollar of GDP. This of course is why many people see green shoots all over the place and hear so many declarations from politicians, economists and the media that the positive GDP growth in the third quarter means the recession is over. They don’t seem to consider that a dollar spend today (increase in GDP) is a dollar that has to be subtracted (from GDP) through taxes later. Nor do they seem to consider that the dollar will be taken from someone who could probably use it more effectively.

2. U.S. fiscal policy is out of control

Government spending is out of control and congress has every intention of spending more and more. The government will pump in at least $1 trillion (above tax collections) this year and probably each year for the next ten years. That’s a lot of GDP “growth.” Add to that any new programs that might be enacted like health care spending or cash for clunkers. Also, the $800 billion stimulus package has not worked (business revenues still falling and unemployment has gone from 5% to 10%.) Yet, according to demand side economists (preferred by most politicians) like Paul Krugman at Princeton, we need another, bigger stimulus package if we really want to turn this economy around.

The government may not (at this time, be able to get another big, trillion-dollar stimulus package through Congress. However, they may be able to get a lot of “little, very targeted stimulus packages” through congress like: $11 billion more for home buyers, $33 billion for businesses on tax losses 3-5 years ago, $250 for each Social Security recipient at a cost of $14 billion, how about another “successful” cash for clunkers program because GM needs money, etc. All of this money will push up the GDP.

3. U. S. monetary policy is out of control

The Federal Reserve has reduced interest rates to 0-.25 percent (basically free money for banks); expanded its balance sheet by $1.75 trillion dollars and guaranteed the financial community $4.3 trillion to make sure banks will trade with other banks. The Fed, at its meeting last week, stated again that it intends to keep interest rates low (where they are) for an extended period of time (until the economy turns around or until they see inflation.)

This “liquidity” not only helps the banks recapitalize, it punishes savers and forces them to buy risk assets if they want to earn a return on their money (or simply spend it and help GDP.) All of this liquidity helps consumption, but it also causes malinvestment and the current “carry trade.”

4. Stable, low-cost money encourages a Carry Trade

This simply means you capitalize on the returns you can get by borrowing money at low rates in one country and investing the funds in another country for a higher return. Remember reading about this when people were borrowing the Japanese yen at zero percent interest and investing in the U.S. at a higher rate of interest. Well, you can do that right now without leaving the U.S. We are now the carry trade. Banks can borrow from the Federal Reserve at zero percent and buy longer term Treasuries and make the difference. Or, some can short the dollar (it’s down over 10 percent this year) and use the money to buy higher risk assets (equities, gold, etc) and make even more.

5. Global funds still streaming into the U.S.

This carry trade is not just being done by Americans, it’s global. Countries around the world have more growth than ever and are taking advantage of the declining dollar and the rising assets like equities, commodities, etc. As we saw in the Technology bubble and the housing bubble, the world is awash in money looking for a place it will be treated well.

These are certainly not all of the reasons the market is rising faster than the economy, but they are some of the more significant reasons. Also they may stay in place until the headwinds become too strong.