California Budget Crisis Poised to Accelerate

Interested observers are wondering about California's looming deadline.

I've been harping on states like California for about 18 months now. Their finances have been terrible for that long (and much longer). But each time the issue appears to be coming to a head, the state congress seems to find a way to postpone the problems by issuing debt, making token service cuts or sneaking in new taxes.

But they've run out of options. Their credit rating is being cut, which eliminates the possibility of issuing debt, voters rejected tax increases on a recent ballot. So massive service cuts are the only option. But it appears that observers have become so tired of hearing the doom and gloom that they have grown complacent to the seriousness of it all.

Problems have been significantly compounded in the last few months due to the sharp drop-off in tax revenues. It seems that for every billion dollars the legislators figure out a way to save another two billion goes missing from budget projections. It's like trying to play table tennis in a hurricane.

Legislators are required to come to an agreement by midnight tonight on how to close the budget. If they don't, the state will suspend payment to "contractors, vendors, local governments and taxpayers expecting refunds" starting on Thursday. They will be replaced with government IOU's which will have an undetermined market value - if anything. This will, of course, start a chain reaction among contractors who will subsequently have to tell their employees there's no paycheck this month. Struggling municipalities will be required to do the same. Those on the dole have already seen their payouts slashed. Government workers will be furloughed another day in July - another 5% drop in monthly pay.

This all has the makings of something very ugly. People being thrown out of work in the middle of summer, while they're being told on TV that banks are set to rake in enormous profits after being bailed out by those on the streets. People keep asking me, "what's it going to take to get this comatose American population to come to their senses and start getting angry?" Maybe it will never happen, maybe this will be the catalyst. But eventually these imbalances that have been growing and growing without consequences will matter. Just because they haven't mattered until now doesn't mean they never will.

The same goes for pension shortfalls, CRE delinquencies, and the plethora of problems that were papered over or shuffled around in the last year. There are perhaps even more imbalances than there were building at around the same time last year, none of them have really gone away or been dealt with. Those that have been dealt with (automakers, residential RE - partly, various other corporate bankruptcies) have been replaced with other, just as large issues that will be met with less willingness from taxpayers to bail out.

But then again, you could just listen to this guy:



Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Technical update 24.09

Another rather uneventful week in the markets passes as investment managers position themselves for quarter-end and Q2 earnings season. Monday saw a sharp selloff for the second week in a row, but most of the losses were recovered on anemic volume as the week wore on. Indeed, market internals have not recovered nearly as fast as price since Monday's beat-down. However, the responsive nature of the major averages in bouncing back from their first support level demands respect and any follow-through on a close above 930 could attract the momentum players and catch some shorts napping. This week promises to be of even weaker volume as Wednesday and Friday are market holidays in Canada and the US respectively.



The Nasdaq continues to outperform the other major indices. After the initial short-covering rallies of March and early April, the Nasdaq has taken the lead. Should the markets continue to push higher into the summer, my expectation is that this dynamic will continue.



The Dow did not fare so well last week. While the others flirted with green, the Dow finished off a full 100 points. This could prove to be a troubling negative divergence for the bulls, as Dow underperformance has foreshadowed many of the major tops of the past 18 months.



Similarly, the German Dax index has taken a bit of a beating over the past 3 weeks, falling nearly 10% from its early June highs. European underperformance has been a hypothesis of mine for a while now. I would not be surprised to see major selloffs in Europe over the summer to new lows accompanied by a refusal of American averages to oblige and subsequent rallies to new '09 highs in Q3, making a final high before rolling over in a big way for 2010. Purely speculative hunch, but that's the way I'm leaning - subject to change at the drop of a hat.



The long bond enjoyed a fairly robust week. I have very little opinion on the future direction of this instrument. But my feeling is that the increasing domestic savings rates and eventual thinning of the US trade deficit will provide a greater appetite for government debt than most anticipate (ala Japan). Additionally, I would not put it past the Treasury to increase the ratio of short term offerings (less than 2 year maturity) and simply keep rolling them over until inflation fears are killed dead.



As you can see, there are no signs of increasing inflation expectations in the short term treasury bill market. If interest rates were going to start booming higher, the savings rate would not be skyrocketing and short term rates would not be so low. Savings would be falling and rates would be rising as those trying to hedge against future inflation would be stocking up on non-durables. That ain't happening. The only place I see inflation is in the amount of hot air coming from the media and capitol hill.



The CRB index does not look all that strong. It has retraced a measly 24.1% of its prior decline. What case for green shoots remain if commodities roll over?



Have a good week!


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Structured Finance Is Expanding Globally

Dated sometime in 2007. Everything had already started coming unglued. Housing had been declining for more than a year. Insiders were selling like crazy. Credit spreads were starting to widen. Bear Stearns teetered on the brink. The savings rate was near zero.

But the most respected credit rating agency in the world was still pumping the wonders of structured finance. These folks are still running the show...

(click image for larger version)





Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Abrogation of Justice Will Delay Recovery Indefinitely

The sanctity of contract law is being rapidly dismantled in the United States. The same laws that have made doing business in the US more secure than anywhere else in the world for centuries, are being torched in favour of political partisanship.

Never mind the economic interventions, the bailouts and rising deficits. Never mind the future taxes that are sure to crush any attempt at a recovery. Never mind the price fixing that is sure to cause shortages. Never mind all that.

The most important factor in determining whether an entrepreneur should invest in future production is the rule of law. Without the unhindered rights to private property and debtor protection in the event of bankruptcy, there is an enormous risk premium put on entrepreneurial activity.

It is for this reason that third world countries cannot manage to develop into civilized economies despite having plentiful natural resources, cheap pools of labour and often even decent education. It is not worth the risk! Why take all the risks of investing in some new factory or piece of farm machinery in order to improve your yearly productivity by 3-4% if some corrupt judge or politician can willy-nilly take that asset from you without compensation? Why bother? Why not just keep your savings buried in a hole in order to ensure you can feed yourself for the next year?

80% of the world's population lives under such circumstances. America seems determined to join them.

My worst fears were realized in the outcome of the Chrysler bankruptcy. In the name of "expediency," the company was torn away from its rightful owners (the secured creditors) and given to union interests, a foreign company (Fiat of Italy) and the US government themselves. Those who had lent Chrysler money over the last decade with the impression that, should worst come to worst, they would at least have claim to the factories, the brand names, etc, were run roughshod over, given mere pennies on the dollar. These people accepted a lower rate of interest on their loans in order to ensure this priority in the event of bankruptcy. Hundreds of years of judicial history was on their side.

There are many reports of certain secured creditors being threatened if they were to stand in front of the proceedings. Many of the larger bond holders were the same banks that had received money under the TARP programs. They were not given a choice. In a round about way, they were paid off by taxpayers to remain silent and not object. And the remaining few holdouts, like the Indiana State Pension Fund, were publicly vilified and subsequently dismissed by the Supreme Court.

One might be led to believe that because all of the creditors eventually agreed to a settlement, that no wrongdoing was committed. But in most cases, going up against the Administration was going to prove even more costly than simply walking away. The press release from investment firm Perella Weinberg sums up the decision making process:

Suggestions have been made that the Perella Weinberg Partners Xerion Fund changed its stance on the Chrysler restructuring due to pressure from White House officials. This is incorrect. The decision to accept and support the proposed deal was made by the Xerion Fund after reflecting carefully on the statement of the President when announcing Chrysler’s bankruptcy filing. In considering the President’s words and exercising our best investment judgment, we concluded that the risks of potentially severe capital loss that could arise from fighting this in bankruptcy court far outweighed any realistic potential upside.

We have a very specific mandate from our investors, and that is to carefully weigh investment risks and rewards. It is not our investment mandate to pursue political or risky legal campaigns with our investors’ money. This was our assessment of investment risk and reward, nothing else.



While we did and still do believe that the lenders would be justified in pressing their objections under conventional bankruptcy law principles, we believe a settlement would now be in the best interests of all parties in the context of avoiding a drawn out contested bankruptcy litigation proceeding, and we encourage our colleagues in the loan syndicate to pursue this immediately.

And so it was. Cronyism at its finest.

But the secured creditors were not the only ones getting screwed. Anyone with an outstanding claim against the former company is now hung out to dry. This includes family members who were killed due to manufacturing defects, anyone pursuing false advertising claims and things of the like. These claimants have been relieved of their legal recourse. People who purchased a vehicle for a price, reasonably thought to include legal liability should something go wrong, have now been denied.

As outrageous as these specific abrogations of justice are, it is obviously not the specific instances that are of the most concern. It is the fact that once set as precedent, any judge is now required to view the Chrysler case as precedent setting. In order to rule otherwise, defense lawyers need to prove beyond reasonable doubt that their case is different.

More specifically, General Motors, a company many times the size of Chrysler is going through the same process as we speak. Thankfully, there is no bidder for the company's assets that can serve as cause to rubber stamp the process. But the precedent has been set for unions and the government to supersede any other claimants. What about other looming bankruptcies? How will other unions feel if they were not to get favourable treatment like the UAW? How will consumer's decisions be affected by the knowledge that a manufacturing defect could leave them high and dry?

But most importantly, what effect is this going to have on the economy as a whole? As mentioned, it is obvious that investment risk has been heightened greatly. Who in their right mind would lend money to a struggling company that requires retrofitting of their factory to become competitive again? Interest rates for these companies are going to skyrocket.

Investment in productive capacity is what gets an economy out of recession. Higher savings rates drive down interest rates, making investments in the early stages of production easily doable - investments that in the previous boom were too expensive to undertake. The ensuing employment created and increase in productivity from the use of this new capacity increases profits for entrepreneurs and a recovery is born.

The Obama Administration and the US Courts of Justice are foolishly cutting the legs out from this process. They mistakenly believe that the reason for the recession is "underconsumption" rather than a lack of profitability of business in the previous expansion. "If people would just consume at the 'equilibrium rate,'" they cry, "then producers would have no reason to fire workers, thus preventing further 'underconsumption.'"

But here we have the classic mistake in neoclassical economic theory. "Equilibrium" is thought to be something totally unrepresentative of normality. Neoclassical economists have no way of determining what equilibrium looks like, so they foolishly assume that the economy was in equilibrium whenever it appeared to be most beneficial to everyone. But what appeared to be most beneficial was an illusion. Fueled by cheap credit provided by the central bank and overly optimistic lenders, people were overconsuming. Now that the inevitable readjustment is taking place, politicians and central planners are trying to fit a square peg into a round hole - an economy plagued by overconsumption into an economy that cannot produce goods profitably.

The denial of legal recourse to those entitled is making it even more difficult to invest profitably and the social aversion to the superficial is killing the consumption goose.

The Obama Administration is doing their best to prevent these opposing factors from coming into balance. Good luck finding a recovery in this mess.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

French: The Deflating Bubble

Perhaps the best explanation of our current situation is summed up today at Mises.org by economist and author Doug French. He explains with applicable quotes from some of the wisest economist of the 20th century what we're experiencing and why nothing the government attempts can possibly work. This is the coles notes version of our predicament.

Read the original article here:

The Deflating Bubble
Mises Daily by Doug French | Posted on 6/22/2009 12:00:00 AM


There is an epidemic of bankruptcies: Circuit City, Sharper Image, Goody's, Gottschalk's, Comp USA, Levitz Furniture, Chrysler, GM. Not to mention all the local businesses that don't make the news when they close up shop. And the rash of corporate bustouts is far from over according to consulting firm Bain & Company, who predicts nearly 100 large ($100 million or more in assets) corporate bankruptcies by next year.

We're in a period of severe losses — a cluster of errors, as Murray Rothbard described it — with thirty-seven banks having failed already this year, and many more to come.

But as gruesome as the economic news sounds, Rothbard explained that this is the recovery.

The liquidation of unsound businesses, the "idle capacity" of the malinvested plant, and the "frictional" unemployment of original factors that must suddenly and en masse shift to lower stages of production — these are the chief hallmarks of the depression stage.

Many would like the boom to continue "where the inflationary gains are visible and the losses hidden and obscure," Rothbard wrote. "This boom euphoria is heightened by the capital consumption that inflation promotes through illusory accounting profits."

But the boom is where the trouble happens — when resources are directed into malinvestments and distortions occur — and trouble we've had this past decade with a Capital T. The M-2 money supply increased 53% since year 2001, while at the same time total bank loans doubled and bank real-estate loans increased over 150%. The mistakes of bad entrepreneurs have been hidden, employment was directed to wasteful and unneeded occupations, unsound projects were built and business risk was ignored.

"The boom produces impoverishment," wrote Ludwig von Mises in Human Action.

But still more disastrous are the moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse.
Many bankers continue to contend that their banks are sound, protesting that they didn't make any subprime loans like those big Wall Street banks. But the cluster of errors doesn't contain itself to one asset. Houses don't suddenly appear. First, land is purchased. Then that land must be entitled — permission from local government must be obtained to build what the owner wants on the property. This is a lengthy process than can in the best case take months and in the worst cases take decades. Infrastructure improvements are then made and finally houses can be constructed.

So, low interest rates spur consumers and investors to buy houses — in some cases creating housing shortages and exploding prices, which, in turn, cause developers to buy land and begin the lengthy development process just described. After money supply increases by way of credit expansion, businesses malinvest by "overinvesting in higher-stage and durable production processes," Rothbard explained in Man, Economy and State.

Real-estate developers by and large use debt financing every step of the way from when they buy the land to when they start construction. In the past, banks traditionally shied away from making land loans. But as the market overheated, more and more banks got in the land-loan business. Land lending is inherently risky because land doesn't produce income and gaining government approvals in a timely manner is often problematic: land is many months from being converted to a use that is salable to the typical consumer. Lending for the construction is the least risky, but still the homes must be sold to pay off the loan.

Guaranty Bank of Austin recently demolished 16 new and partially built homes in Victorville, California. The cost of finishing the development exceeded what they could sell the homes for despite four of the homes already being complete. In early 2008, these homes were selling for $280,000 to $350,000 in the bedroom community 50 miles from LA.

The Victorville demolition is one of the most dramatic ends to a bad bet made during the housing boom, but abandoned developments have become an all-too-common sight in California. Nearly 250 residential developments totaling 9,389 homes have been halted across the state, according to one research firm.

And the residential meltdown is nowhere close to being over. There is reportedly a million-house overhang in the market nationwide. But misguided attempts by government are keeping home prices from correcting to affordable levels. "If an investor could purchase a home and rent it out for close to breakeven," real-estate broker Mike Morgan writes in Barron's, "we might be getting close to the bottom. But we are nowhere close to that level in most critical markets."

Morgan points to a California program that offers a $10,000 tax credit for buyers of new homes. Thus, encouraging the building of redundant houses, at the same time homes are being bulldozed in Victorville. The annual sales pace is 300,000 homes, yet 500,000 new homes are being started that will just add to a bloated inventory.

What Morgan calls the back half of the residential-real-estate hurricane will destroy bank balance sheets. "Our experience with banks' selling REOs is they realize about 50% — 75% of what they initially think they will get," explains Morgan.

But the current crisis doesn't end with residential real estate. Commercial-real-estate developers follow roof tops. When they see homes being built, they forecast that those homeowners will need places to shop and places to work — so the residential-construction boom inevitably leads to a commercial-property boom: office and industrial buildings as well as shopping centers. All those new homeowners will need to buy everything from groceries to garden hoses. Plus, new title company, mortgage loan, construction, and other real-estate-dependent jobs are created, meaning more office and industrial space will be required.

And lenders were there to embrace their developer customers' dreams and supply the credit. Commercial mortgages and construction loans exploded in the boom years. "Tiny cap rates, feckless lending and willful ignorance were par for the course in those years when the market could hardly seem to walk a straight line," writes Grant's Interest Rate Observer.

But with the finding of new tenants difficult and the rash of bankruptcies of current renters, commercial-property values are plunging. The Moody's/REAL Commercial Property Price Index has fallen over 21 percent since it peaked in October 2007. And the folks at Deutsche Bank see price declines of 35 to 45 percent and maybe more in commercial property, due to the large number of loans coming due between now and 2012 that will not be able to be refinanced. Not only are loan delinquency rates up and rents down, but the go-go years of aggressive loan underwriting are gone. The interest-only, high-loan-to-value-ratio loans that drove capitalization (cap) rates to the five percent range are history. Property buyers who are required to put more money down will offer significantly less for the same net operating income to achieve the required return on investment.

"Volume [of real-estate transactions] in the Americas has fallen hardest with the first quarter 2009 sales down 84% year-over-year and 56% from the fourth quarter of 2008," according to REAL Capital Analytics.

This spells further trouble for the small community banks that make up just 28% of the banking industry's total assets but are responsible for about 60% of the nation's commercial-real-estate lending.

So while many bankers contend their institutions are sound, bank attorney Gerald Blanchard told US Banker, "Across the U.S. right now there are still a fair number of community and regional banks with significant problems."

"There are banks in the sunbelt and other areas sitting on developed lots — lots that have been bulldozed, wired, and paved but not built on — worth 15 to 20 cents on the dollar," Blanchard says. "Those institutions with heavy investments are suffering big losses and big hits to capital. So yes, we will continue to see failures." Blanchard went on to say that newer banks will not be lending to builders and depending on brokered deposits to grow their banks, as they did in the boom.

A contraction of credit and liquidation of assets is exactly what would complete this recovery. Failing real-estate prices, business failures, and high unemployment signal that the economy is desperately trying to heal but the Fed is fighting valiantly to re-inflate, increasing its balance sheet 140% just to generate a 14% increase in the M-1 money supply. The folks at Grant's estimate the federal response to the current downturn to be 12 greater than that to the Great Depression, which prolonged that recovery for a decade.

However, all of this government intervention will only spawn new malinvestments and later depressions. "It should be clear that any governmental interference with the depression process can only prolong it," explained Rothbard "thus making things worse from almost everyone's point of view." Further delay of the readjustments will only lengthen the depression, postponing complete recovery indefinitely.

"The larger the scope of malinvestment and error in the boom," predicted Rothbard, "the greater and longer the task of readjustment in the depression." Government intervention on all levels guarantees that this will be a very long, bumpy recovery.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Technical update 23.09

The major market averages closed the week near the same level they did 7 weeks ago. The fairly strong downside reaction from overhead resistance and through the first level of support (but not closing below) suggests that the first major correction of the post-March advance is underway. Depending on the nature of decline, we should be able to tell with reasonable accuracy whether this decline is suggestive of continuation below, likely far below the March lows, or if it is corrective, suggesting one last move above the June highs, with a potential target of 1100.

We are now embarking on what are typically slow summer months in terms of volume - a trend that has been completely ignored over the past 3 summers, with sharp selloffs in June/July '06 August '07 and July '08. Of course, what seemed to be "sharp" at the time hardly looks that way in comparison with the selloff in late '08. Nevertheless, seasonality has been a very prevalent factor over the past few years. Whether that means we're "due" for a headfake and summer long rally, I don't know. But after the roller coaster of the past year, I can easily imagine money managers flattening their exposure to spend some time with their families. As we approach quarter end, I think that dynamic can take hold as in past years.



Regular readers know that I use Exponential Moving Averages as a means for providing context to price, which are exponentially weighted toward recent price movements, while most market analysts use Simple Moving Averages, which are unweighted averages of the whole period. It is important to point out that for those using the simple moving averages, one must pay attention to numbers that will be "falling off" the back end. Currently, the 200 day simple MA is starting to "lose" its readings of the pre Sept/Oct crash, meaning that the average should start falling like a stone. Many trading algorithms use distance from moving averages as buy/sell signals, so this could be something to keep an eye one. I've included a daily chart showing the difference between the 200 day simple (green) and the 200 day exponential (red) averages.



While volatility has fallen to where I had earlier targeted (high 20's) as a probable nadir, it bears mentioning that it has occurred sooner than I would have liked. The times between June and July expiries are statistically the lowest readings for volatility. For those thinking of purchasing autumn options, be aware that the volatility premiums can be considerably zapped from even these levels. Then again, front month volatility is not always a good indicator for distant premiums. This is illustrated well in the gap between the $VIX (front month) and the $VXV (3 month forward). Back in Oct/Nov the VXV was projecting more normalized volatility (lower) through the new year. It is now projecting higher volatility for September than the front month.




Consistent with my forecast for lower equities, I see USD strength relative to the Euro and other paper currencies. As long as the dollar index remains above last weeks lows (79.19), I consider the trend to be up. Otherwise, we would be looking at a further drop to ~76 before finding a lasting bottom to the countertrend move.



I am still waiting for Gold to make its visit with the October lows. Seasonality is still unfavourable for another couple of months. Hopefully we see a window of opportunity to purchase in late summer.



That's all for now.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Chinese Green Shoots Also An Illusion

One of the favourite targets of pollyanish green shootery has been China. I suppose this stems from the ancient ancestor of green shoots: the asian decoupling theory. Naturally, this theory was rooted in ignorance of the primary source for emerging market strength, which was, of course, easy and abundant credit in the west. Now that the latter matter has all but disappeared, taking the former with it in 2008, this same lot appear to be doubling down on their losing bets, hoping for a turbo-charged Chinese-led recovery.

If only it were so easy.

Putting aside mindless platitudes like, "every one of those 3 Billion Asians wants to drive a car like us," the growth engine of China specifically (but all of asia generally) has been on exporting cheap crap to the US. So while consumer credit dries up (and for the first time in decades is actually paid back[!]), unemployment continues its seeming ascent to infinity and balance sheets are otherwise squeezed like a sunday morning orange, it should be no surprise that the first expenses done away with are those which the preceding credit boom allowed them to feast on. Believe it or not, while it is every man's dream to be able to wear a new pair of socks every day, the loss of one's job is typically enough to encourage the odd "laundry day" every now and then. So I'm sorry, Jiao. Your services will no longer be needed.

I typically make it a point not to rely on government statistics (and communist government statistics in particular) to support or refute analysis that can be better done with common sense. Recent data, however, has proven to be both troubling and confusing, oftentimes directly contradicting itself. And it is in such overt contradictions that one can plainly see the Chinese government's paranoia with the current economic situation, rather than the calm confidence they attempt to project.

The best such contradiction is seen in the gap of electrical output and industrial production. Now, I put very little weight on the validity of either of these numbers as an indicator of general economic activity per se, but the fact that the two series tracked each other very closely throughout the boom phase, then miraculously began to diverge while the rest of the world was itself undergoing turmoil would be supportive of the hypothesis that the Chinese economy is not immune to the law of gravity. And then there's always the icing on the cake: China has now discontinued publication of electrical output statistics. Merely a coincidence, I'm sure.

Andy Xie writing for Cajing has an important take on another issue: China's rising demand for raw materials. Without further elucidation, I invite you to read it in its entirety:

China's credit boom has increased bank lending by more than 6 trillion yuan since December. Many analysts think an economic boom will follow in the second half 2009. They will be disappointed. Much of this lending has not been used to support tangible projects but, instead, has been channeled into asset markets.

Many boom forecasters think asset market speculation will lead to spending growth through the wealth effect. But creating a bubble to support an economy brings, at best, a few short-term benefits along with a lot of long-term pain. Moreover, some of this speculation is actually hurting China's economy by driving asset prices higher.

The current surge in commodity prices, for example, is being fueled by China's demand for speculative inventory. Damage to the domestic economy is already significant. If lending doesn't cool soon, this speculative force will transfer even more Chinese cash overseas and trigger long-term stagflation.

Commodity prices have skyrocketed since March....The weak global economy can't support high commodity prices. Instead, low interest rates and inflation fears are driving money into commodity buying.

Exchange-traded funds (ETFs) alone account for half of the activity on the oil futures market. ETFs allow retail investors to act like hedge funds. This product has serious implications for monetary policymaking. One consequence is that inflation fears could lead to inflation through massive deployment of money into inflation-hedging assets such as commodities.

Financial demand alone can't support commodity prices. Financial investors can't take physical delivery and must sell maturing futures contracts. This force can lead to a steep price curve over time.

Early this year, the six-month futures price for oil was US$ 20 higher than the spot price. Investors faced huge losses unless spot prices rose. A wide gap between spot and futures prices increased inventory demand as arbitrageurs sought to profit from the difference between warehousing costs and the gap between spot and futures prices. That demand flattened the price curve and limited losses for financial investors. Without inventory demand, financial speculation doesn't work.

For some commodities, warehousing costs are low, limiting net losses for financial buyers. Some commodities can be used just like stocks, bonds and other financial products. Precious metals, for example, are like that. Copper, although 5,000 times less valuable than gold, still has low warehousing costs relative to its value. Some commodities such as lumber and iron ore are bulky, costly to warehouse, and should be less susceptible to financial speculation. Chinese players, however, are changing that formula by leveraging China's size. They've made everything open to speculation.

There's little doubt that China's bank lending since last December has driven speculative inventory demand for commodities. Chinese banks lend for commodity purchases, allowing the underlying commodities to be used as collateral. These loans are structured like mortgages.

Banks usually have to be extremely cautious about such lending, as commodity prices fluctuate far more than property prices. But Chinese banks are relatively lenient....

The international media has been following reports of record commodity imports by China. The surge is being portrayed as reflecting China's recovering economy. Indeed, the international financial market is portraying China's perceived recovery as a harbinger for global recovery. It is a major factor pushing up stock prices around the world.

But China's imports are mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used financing for speculation. The first wave of purchases was to arbitrage the difference between spot and futures prices. That was smart. But now that price curves have flattened for most commodities, these imports are based on speculation that prices will increase. Demand from China's army of speculators is driving up prices, making their expectations self-fulfilling in the short term....

The iron ore market has been brutal for China, partly due to China's own inefficient system. China imports more ore than Europe and Japan combined. Skyrocketing prices have cost China dearly.

For four decades before 2003, fine iron ore prices fluctuated between US$ 20 and US$ 30 a ton. As ore was plentiful, prices were driven by production costs. After 2003, Chinese demand drove prices out of this range. Contract prices quadrupled to nearly US$ 100 per ton, and the spot price reached nearly US$ 200 a ton in 2008.....

China's local governments have been obsessed with promoting steel industry growth....But the spot market is relatively small, and mines can easily manipulate spot prices by reducing supply. On the other hand, numerous Chinese steel mills simultaneously want to buy ore to sustain production so their governments can report higher GDP rates, even if higher GDP is money-losing. China's steel industry is structured to hurt China's best interests.

As steel demand collapsed in the fourth quarter 2008 and first quarter 2009, steel prices fell sharply. That should have led to a collapse in ore demand. But the bank lending surge armed Chinese ore distributors, giving them money for speculating and stocking up....

What is happening in the commodity market is glaring proof that China's lending surge is hurting the country. Even more serious is that it is leading Chinese companies away from real business and further toward asset speculation – virtual business...

As the economy weakened in late 2008, private lenders began demanding money back from distressed private companies. Loans from state-owned enterprises may have kept many private companies from going bankrupt. It has served to re-channel bank lending into cash for individuals and businesses that were in the lending business. This money may have flowed into asset markets. It is part of the phenomenon of the private sector withdrawing from the real economy into the virtual one.

It's worrisome that businessmen have become de facto fund managers and speculators. This happened 10 years ago in Hong Kong, and since then the city's economy has stagnated. Some may argue that China has SOEs to lead the economy. However, private companies account for most employment in China, even though SOEs account for a larger portion of GDP. Now, the government is spending huge amounts of money to provide temporary employment for 2009 college graduates. If private sector employment doesn't grow, the government may have to spend even more next year. The government is using fiscal stimulus and bank lending to support economic recovery. But the recovery may be a jobless one. China needs a dynamic private sector to resolve the employment problem.

We are seeing a dark side to the lending surge as commodity speculation hurts the economy. More lending may lead to higher commodity prices, threatening stagflation. Cheap loans benefit overseas commodity suppliers, not necessarily the Chinese economy. Lending policy should consider this self-inflicted damage.

Many analysts argue GDP growth follows loan growth, and inflation is a problem only when the economy overheats. This is naive. Borrowed money channeled into speculation leads to inflation. And China may face a lasting employment crisis if private companies don't expand.

This lending surge proves China's economic problems can't be resolved with liquidity. China's growth model is based on government-led investment and foreign enterprise-led export. As exports grew in the past, the government channeled income into investment to support more export growth. Now that the global economy and China's exports have collapsed, there will be no income growth to support investment growth. The government's current investment stimulus is tapping a money pool accumulated from past exports. Eventually, the pool will dry up.

If exports remain weak for several years, China's only chance for returning to high growth will be to shift demand to the domestic household sector. This would require significant rebalancing of wealth and income. A new growth cycle could start by distributing shares of listed SOEs to Chinese households, creating a virtuous cycle that lasts a decade.

Putting money into speculative investments isn't totally irrational. It's better than expanding capacity which, without export customers, would surely lead to losses. Businesses currently lack incentive to invest. But many boom forecasters wrongly assume that recent asset appreciation, fueled by speculation, signaled an end to economic problems. That's an illusion. The lending surge may have created more problems than it resolved.

Why do I have a feeling that Andy Xie's analysis will also soon be discontinued by the Chinese Government?

I have another theory of what China is planning to do with their stash of industrial commodities. And it would have more to do with an observation of Richard Koo, who offers that the most effective use of capital to combat economic stagnation is through military expenditures. I don't necessarily agree - expending resources solely for the purpose of destroying capital does not provide the grounds for economic health - but I don't often agree with Chinese policy.

My hypothesis remains as offered in late 2007:

The Chinese stock market continues to defy gravity but is another one of those things that can’t go on forever. The same can be said about the Korean Kospi, Brazilian Bovespa, Indian Sensex and other emerging stock markets. A consumer slowdown in the US and rising input costs means these economies will need to re-tool their manufacturing base to maintain the same levels of profit growth. A synonym for re-tooling the economy is ‘recession’, and emerging markets aren’t any more immune to the business cycle than we are. This doesn’t mean they go back to living in mud huts. It means capital is redeployed to more efficient uses. This sudden realization of mortality will mean big declines at some point. I think that day will come in 2008.

As in the US and around the world, the early part of this re-tooling has been met with stern opposition from the government. This postpones it rather than prevents it. And China's phony economy is no more legitimate than the US's phony economy. As Andy Xie points out, attempts to make it "more phony" in order to mask this transition is going to make the process more difficult, not less. And so China teeters on the brink of collapse. Whether this collapse is acknowledged by the government spin-doctors in Beijing is irrelevant to me.

The law of gravity has not been repealed. Not in Vancouver. Not in New York. Not in China.

Disclosure: Long Parachutes

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Just Guessing

I signed on to Bloomberg this morning to get glimpse of what "the other side" is thinking. I don't know why I bother. When I see things like the below, all that I can envision of are a bunch of monkeys in diapers frantically pressing buttons.

Maybe the editor got distracted by Rebecca Jarvis on CNBC? Who knows. Even I've succumbed to that. But I just don't know how this passes through the editorial filter. Either that or it occurs to them entirely logical that the stock market rise on economic concerns as some sort of a "safe haven." After what I've seen over the past year, I sadly can't rule this out as a possibility.



Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Krugman Totally Discredited

Ever since I started this blog, one of my favourite targets has been Paul Krugman and Keynesian economists in general. Typically, debating economic theories is exhausting. But Krugman makes it easy - constantly spewing the most ridiculous economic fallacies with reckless disregard for simple logic.

A number of other financial blogs have taken Krugman to task of late, and never being one to pass up a good opportunity, I feel obliged to pile on in hopes that perhaps one more knock on his credibility will be enough to unseat him as a legitimate economist. This is something that should have been done a long time ago. Before he started writing for the NY Times and before he was awarded a Nobel Prize for, uh, what exactly?

The most recent barrage of attacks on his legitimacy has been in regards to his self-defense of what his proposed policies were in the aftermath of the dot.com collapse. Krugman is the prototypical Keynesian. A government bureaucrat's best friend. His solution to any problem is for government to spend more money and for central banks to create more money. So naturally, after the bubble had popped in 2001, Krugman was egging Alan Greenspan on to do more - even as interest rates were being slashed and lending standards were being thrown in the dustbin of history.

I had, perhaps foolishly assumed, that Krugman would at least own up to this misjudgment, this massive overraction. I had thought he would have issued a mea culpa along the lines of, "hey, at the time things looked pretty bleak and only in hindsight can we see that was the wrong course of action." I assumed his loyal social democrat fans had simply brushed off this rather large misstep and given him the benefit of the doubt. But here, I have committed one of the most crass of Keynesian errors: I assumed too much.

Far from actually owning up to his poor judgement, Krugman has actually gone so far as to deny his stated intent at the time. Thankfully, we have the internet. And the internet never forgets.

To start, we look at Krugman's post this week:

One of the funny aspects of being a somewhat, um, forceful writer is that I’m regularly accused of all sorts of villainy. I was personally responsible for the demise of Enron; my nonexistent son worked for Hillary; etc.. The latest seems to be that I called for the creation of a housing bubble — in fact, the bubble is my fault! The claim seems to be based on this piece.

Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.

I knew this was a pile of crap before even looking into it further. Krugman (and all Keynesians) explicitly advise inflation as a matter of public policy during every recession. It goes hand in hand with insistence on an "elastic currency" (ie. inflatable currency). But not only is his denial inconsistent with basic Keynesian economics, but it is a total cop-out, and a very typical one at that. It is a bit of a trend that I have noticed for economists to do this. Krugman argues for a certain policy measure to be taken from the vantage point of someone else (in this case Greenspan). This way, if it doesn't work out, one can say that it was not explicit advice. If it does work out, all the credit can be taken. Kind of like saying, "if I were you, I'd order the steak dinner." When the person says the steak was terrible, you can respond by saying, "aha, I said 'if I were you.' But I'm not you, so you can't blame me for ordering it."

Of course, there's far more evidence to suggest Krugman is not only shrewdly playing with words or being inconsistent. He explicitly stated on his very own blog a number of times his desire for a housing bubble to replace the tech bubble. And it is clear that he is advocating it as policy - policy that was, as we know, adopted into practice.

Senior fellow at the Ludwig von Mises Institute, Mark Thornton, combed through Krugman's old posts. What he found is posted below:

German Interview, undated

http://www.pkarchive.org/global/welt.html

"During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn't you lower interest rates?"

May 2, 2001

http://www.pkarchive.org/column/5201.html

I've always favored the let-bygones-be-bygones view over the crime-and-punishment view. That is, I've always believed that a speculative bubble need not lead to a recession, as long as interest rates are cut quickly enough to stimulate alternative investments. But I had to face the fact that speculative bubbles usually are followed by recessions. My excuse has been that this was because the policy makers moved too slowly -- that central banks were typically too slow to cut interest rates in the face of a burst bubble, giving the downturn time to build up a lot of momentum. That was why I, like many others, was frustrated at the smallish cut at the last Federal Open Market Committee meeting: I was pretty sure that Alan Greenspan had the tools to prevent a disastrous recession, but worried that he might be getting behind the curve.

However, let's give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed's four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It's still not clear that Mr. Greenspan has caught up with the curve -- let's have at least one more rate cut, please -- but the interest-rate cuts do, cross your fingers, seem to be having an effect.

If we succeed in avoiding recession, this will mark a big win for let- bygones-be-bygones, and a big loss for crime-and-punishment. And that will be very good news not just for this business cycle, but for business cycles to come.

July 18, 2001

http://www.pkarchive.org/economy/ML071801.html

"KRUGMAN: I think frankly it's got to be -- business investment is not going to be the driving force in this recovery. It has to come from things like housing, things that have not been (UNINTELLIGIBLE).

DOBBS: We see, Paul, housing at near record levels, we see automobile purchases near record levels. The consumer is still very much in this economy. Can he or she -- or I should say he and she, can they bring back this economy?

KRUGMAN: Well, as far as the arithmetic goes, yes, it is possible. Will the Fed cut interest rates enough? Will long-term rates fall enough to get the consumer, get the housing sector there in time? We don't know"

August 8^th 2001

http://www.pkarchive.org/economy/ML082201.html

"KRUGMAN: I'm a little depressed. You know, inventories, probably that's over, the inventory slump. But you look at the things that could drive a recovery, business investment, nothing happening. Housing, long-term rates haven't fallen enough to produce a boom there. The trade balance is going to get worst before it gets better because the dollar is still very strong. It's not a happy picture."

August 14, 2001

http://www.pkarchive.org/column/81401.html

"Consumers, who already have low savings and high debt, probably can't contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery.... But there has been a peculiar disconnect between Fed policy and the financial variables that affect housing and trade. Housing demand depends on long-term rather than short-term interest rates -- and though the Fed has cut short rates from 6.5 to 3.75 percent since the beginning of the year, the 10-year rate is slightly higher than it was on Jan. 1.... Sooner or later, of course, investors will realize that 2001 isn't 1998. When they do, mortgage rates and the dollar will come way down, and the conditions for a recovery led by housing and exports will be in place.

October 7, 2001

http://www.pkarchive.org/economy/ML071801.html

"Post-terror nerves aside, what mainly ails the U.S. economy is too much of a good thing. During the bubble years businesses overspent on capital equipment; the resulting overhang of excess capacity is a drag on investment, and hence a drag on the economy as a whole.

In time this overhang will be worked off. Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. But it seems inevitable that there will also be a fiscal stimulus package"

Dec 28, 2001

http://www.pkarchive.org/column/122801.html

"The good news about the U.S. economy is that it fell into recession, but it didn't fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed's dramatic interest rate cuts helped keep housing strong even as business investment plunged."

Those are just the applicable quotes from 2001. Other astute investigators have pulled out this quote:

NYT Editorial, August 2nd, 2002

http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip.html

To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

It should be absolutely clear what Krugman's intention was. It was the same intent that drives all inflation proponents - to confiscate wealth from savers in order to benefit special interests, notably the banking industry, and to ensure that government has the means to waste money on social projects, wars, and the enrichment of bureaucrats and policy advisors (of which Krugman is exhibit A).

So it should be no surprise to us that Krugman and other notable Keynesians are unconscionably advocating that government attempt to inflate its way out of this mess as well. Anything to save the utopian bloated government that they worship. Anything to save the confiscatory system that has enriched them to this point. They know as well as anyone else, that a liquidation of the malinvestment they created would leave them standing naked. So they scratch and claw to keep their perceived legitimacy.

Thankfully for us, the internet doesn't forget. Keynesians cannot deny that they caused the crash like they did in the 30's. The evidence is as clear as the sky is blue. And no matter how hard they try to blow, there is no bubble big enough to replace the housing/consumption/derivatives bubble that has preceded this. People are sick of the serial bubble blowing and they won't play along any longer. The massive credit creation attempts are being met with the sound of crickets. Consumers aren't borrowing - even at low rates. In fact, they're paying back debt instead. Corporations aren't borrowing to invest in productive capacity. They're firing workers and paying off debt as well. Like all credit bubbles, the chickens are coming home to roost. Government spending isn't even close to being able to replace the private sector. The deflationary spiral that Keynesians have promised to be a relic of the past, isn't. It was only postponed. Instead of experiencing a couple of months of deflation every 4 years, we're getting 80 years of it at once. It is going to be terrible. It is going to be vicious.

But if there's one positive that we can take away it's this: a century of baseless theories that have plagued us without end will be relegated to the dustbin of history. After what we are about to go through, no possible justification for the rampant inflationism, thoughtless interventionism and morally backward focus on price stability will ever be tolerated again.

And economists like Paul Krugman will be a mere footnote in books that nobody will bother reading.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Sick of the Spin

Folks, I know being a card carrying member of the alternative media likely makes me biased. But I don't know how to explain the below other than simply atrocious financial journalism with at least an attempt at maliciousness via a misrepresentation of information.

Housing start numbers were released for the US today and there was really very little to report either way. But Yahoo took matters into its own hands:



The full text of the article follows:

WASHINGTON (AP) -- Construction of new homes jumped in May by the largest amount in three months, an encouraging sign that the nation's deep housing recession was beginning to bottom out.

The Commerce Department said Tuesday that construction of new homes and apartments jumped 17.2 percent last month to a seasonally adjusted annual rate of 532,000 units.

That was better than the 500,000-unit pace that economists had expected and came after construction fell in April to a record low of 454,000 units.

In another encouraging sign, applications for building permits, seen as a good indicator of future activity, rose 4 percent in May to an annual rate of 518,000 units.

The better-than-expected rebound in construction was the latest sign that the prolonged slump in housing is coming to an end, which would be good news for the broader economy.

The current recession -- the longest since the Great Depression -- was triggered by a collapse in the housing market that led to soaring loan losses and a banking system crisis. A healthy home market is needed to support an economic recovery.

President Barack Obama is scheduled to unveil on Wednesday the administration's plan to overhaul financial regulation in an effort to crack down on the lending abuses that triggered the most severe upheaval in the nation's financial system in seven decades.

Even with the encouraging news, analysts don't expect a quick rebound in housing, since the economy is still shedding jobs and home prices are falling in many places, making people hesitant to commit to buying a new home.

Many economists say home construction likely will stop falling in the current quarter but any sustained rebound isn't expected to take hold until next spring.

That's partly due to the huge overhang of unsold homes and a record wave of mortgage foreclosures dumping more unsold homes on the market.

The 17.2 percent rise in housing construction for May still left activity 45.2 percent below where it was a year ago.

The jump reflected a 7.5 percent rise in construction of single-family homes. Construction of multifamily units rose 61.7 percent in May to an annual rate of 131,000 units. This volatile part of the market plunged 49.4 percent in April.

Minuets later, Calculated Risk reports:



Housing Starts May

Total housing starts were at 532 thousand (SAAR) in May, rebounding from the all time record low in April of 454 thousand. The previous record low was 488 thousand in January (the lowest level since the Census Bureau began tracking housing starts in 1959).

Single-family starts were at 401 thousand (SAAR) in May; above the record low in January and February (357 thousand) and above 400 thousand for the first time since last November.

Permits for single-family units were 408 thousand in May, suggesting single-family starts will remain at about the same level in June.

Here is the Census Bureau report on housing Permits, Starts and Completions.

Building Permits:
Privately-owned housing units authorized by building permits in May were at a seasonally adjusted annual rate of 518,000. This is 4.0 percent (±1.7%) above the revised April rate of 498,000, but is 47.0 percent (±2.1%) below the May 2008estimate of 978,000.

Single-family authorizations in May were at a rate of 408,000; this is 7.9 percent (±1.5%) above the revised April figure of 378,000.

Housing Starts:
Privately-owned housing starts in May were at a seasonally adjusted annual rate of 532,000. This is 17.2 percent (±14.4%) above the revised April estimate of 454,000, but is 45.2 percent (±5.8%) below the May 2008 rate of 971,000.

Single-family housing starts in May were at a rate of 401,000; this is 7.5 percent (±14.2%)* above the revised April figure of 373,000.

Housing Completions:
Privately-owned housing completions in May were at a seasonally adjusted annual rate of 811,000. This is 3.3 percent (±20.6%)* below the revised April estimate of 839,000 and is 28.8 percent (±11.1%) below the May 2008 rate of 1,139,000.

Single-family housing completions in May were at a rate of 491,000; this is 9.4 percent (±13.8%)* below the revised April figure of 542,000.

Note that single-family completions of 491 thousand are still significantly higher than single-family starts (401 thousand). This is important because residential construction employment tends to follow completions, and completions will probably decline further.

It is still too early to call the bottom for single family starts in January, however I do expect single family housing starts to bottom sometime in 2009.

So tell me, if you were objectively trying to obtain information where would you turn? To the multi-billion dollar conglomerate with the power of the American Press at its side? Or to the guy who runs the same information out of his living room while maintaining the same kind of turnaround time (more or less)?

I'll let you decide. But to me, the choice is clear. There is absolutely no reason to continue reading newspapers, watching television or even visiting mainstream financial websites. The dissemination of information has been left to the free market, and guess what? The natural competition that has arisen is destroying the former media monopolies.

Good riddance.

Update:

A totally unrelated, yet far more disturbing development I came across this morning:

ABC Turns Programming Over To Obama

(this is now a confirmed report by the RNC - no tinfoil required)

ABC TURNS PROGRAMMING OVER TO OBAMA; NEWS TO BE ANCHORED FROM INSIDE WHITE HOUSE
Tue Jun 16 2009 08:45:10 ET

On the night of June 24, the media and government become one, when ABC turns its programming over to President Obama and White House officials to push government run health care -- a move that has ignited an ethical firestorm!

Highlights on the agenda:

ABCNEWS anchor Charlie Gibson will deliver WORLD NEWS from the Blue Room of the White House.

The network plans a primetime special -- 'Prescription for America' -- originating from the East Room, exclude opposing voices on the debate.

I have said for a long time that America has transformed into a fascist state. It started with Bush and is accelerating under Obama. The logo you see above is that of the Obama Administration - the rising sun of sorts over the American flag - now juxtaposed with the ABC logo. I would be hypocritical to not point out, however, that Fox News appears to be doing the same with the Republican Party.

It may seem a bit sensational to some for me to equivocate Obama/Bush with fascism. But I let the evidence speak for itself. And the evidence tells me that the major corporate interests (including the media) and the interests of the government are one and the same. That, taking place anywhere else, is undeniably fascist.

But that's okay. I'm sure everything will work itself out. No need to do anything about it. You may return to your regular programming...

Update #2: You didn't really think they were going to just stop reading our e-mails and intercepting telephone calls when Bush passed the baton, did you? Of course not, so this isn't surprising to anyone.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

No Way Out

For those condemned to a perpetual stream of American-centric financial media, I will continue pointing out the issues confronting Europe.

Ambrose Evans-Pritchard continues as one of the only remaining mainstream writers with a sense of journalistic integrity. Yesterday, he delved into the highly explosive issue of Latvia and how the centralized decision making in Brussels has doomed it to an ill fate. Unfortunately, AEP comes armed with the neoclassically fallacious idea that debt deflation is always and everywhere an evil, rather than a blessing, that "deflation" and "depression" are synonymous, and that government stimulus spending is a legitimate method of inducing economic recovery. Nevertheless, he manages to consistently turn over rocks in search of termites. And guess what, he finds them. Furthermore, he displays a rare ability to weight the significance of his findings through a causal-realistic interpretation of economic history.

From the Daily Telegraph:

Contrary to revisionist talk, Argentina was not a basket case. Its imbalances were no worse than those of the Baltics, Balkans, Spain, or Greece, and arguably better.

It ran a trade surplus in 1999 and 2000 until dollar revaluation against Brazil and Europe crushed exports. The economy shrank 5pc in 2001, mild compared to Latvia's 20pc slump this year.

Yet Argentina span out of control very fast in December 2001 when President Fernando de la Rua stopped cash withdrawals from banks. There was a national strike. Co-ordinated mobs stormed supermarkets.

On the 17th, de la Rua ordered a 20pc cut in public spending. (Like cuts just passed by Latvia's parliament). It set off three days of rioting fanned by Peronist agitators. De la Rua declared an emergency. The army refused to act without backing from congress. Police lost control. Some 27 people were killed on the 20th.

Trapped in the Casa Rosada by furious crowds, De la Rua fled in an air force helicopter. After five presidents in two weeks, Argentina ended a half-baked dollar union that had lured its people into a debt trap. Dollar mortgages − 90pc of home loans − were switched into pesos by decree. Foreign creditors received a 70pc haircut.

The country recovered, as countries do once suicidal policies of monetary deflation are halted. In a sense, Argentina did what Britain and America did in the 1930s by coming off gold. Creditors didn't like that either, but Anglo-Saxon democracies at least survived to save capitalism.

Latvia looks well-advanced in this political chain. As our Moscow correspondent reports, three of Latvia's eight Euro-MPs elected last week are pro-Kremlin. The Harvest Party of ex-Communist strongman Alfreds Rubiks came first in local elections, backed by both ethnic Russians and disgusted post-capitalist Latvians.

If the purpose of Baltic euro pegs is in part to keep Putin's Russia at bay by locking the region deeper into the EU Project, the strategic gamble has gone badly wrong. It has created a reservoir of Russian irredentism in both Latvia and Estonia that gives Moscow a pretext to intervene at any time. The Baltics are being offered to Putin on a platter.

Latvia is firing a third of its teachers. The welfare state is being dismantled. Pensions for those in work will be cut 70pc. The salaries of doctors, nurses, and police (nota bene) will be cut 20pc. Unemployment has risen from 6pc to 17pc in a year, and is still rising. Jobless benefits for most will run out in the autumn, reducing support to £40 a month. "It is time to take to the streets," said union leader Valdis Keris.

So why is Riga persisting with peg crucifixion? The central bank has burned a tenth of its reserves in a fortnight. Overnight rates have topped 200pc. Why go on? No doubt devaluation would be a shock for middle class Latvians with euro and Swiss franc mortgages, but they face punishment either way – slowly by debt deflation, fast by devaluation. Swedish banks with $75bn of exposure to the Baltics have already thrown in the towel, accepting that it might be better for all to lance the boil.
The usual IMF strategy in these cases is to devalue by 30pc or so, which allows boom-busters to export their way back to health. Further rescue loans change little without this liberating action. They add debt, and draw out the agony.

We know from leaked documents that the Fund advised Latvia to ditch the peg last year. IMF experts were overruled by Brussels. The reason, of course, was to prevent: 1) a chain of falling dominoes in Eastern Europe; 2) a default shock for West European banks with $1.6 trillion (£970bn) of exposure to the region; 3) leakage from Bulgaria across the EU line into Greece – euroland's Achilles heel.

Latvian society is being sacrificed to buy time for EMU's dysfunctional system. It is the designated martyr for the EU Project.
When Latvians wake up to what is being done to them, more than a wretched peg will go.

Pritchard gets it right in his comparison with Argentina. He could have used any number of other relevant examples such as Thailand 3 years earlier.

But what he has left out is that currency pegs never work. They always blow up because of the incentive governments and central banks have to juice the supply of money and credit to achieve political ends. In this case, Latvia experienced an enormous boom following its adoption into the EU. Foreign investment caused a boom that made Southern California look rational. The money supply expanded enormously, forcing the central bank to defend the peg that was imposed by the EMU as a precondition to eventual adoption of the Euro. The enormous cost of doing this put huge pressure on the government budget, causing fears that the government would not be able to make good on its claims. Those fears were realized when CDS spreads started blowing out, interest rates started rising and its sovereign credit rating was cut.

Latvia has no way out. The conditions AEP mentions above are precisely what needs to happen in order to correct the malinvestment made over the last decade. The debt, which is denominated primarily in Euros and Francs will be defaulted on, while the currency slowly erodes away to nothing - its true value.

It is with these kinds of conditions that hyperinflation is inevitable. However, for those currencies which have large amounts of their money supply outstanding as debt, the opposite is the case. The scramble to pay back debt combined with the default of yet more debt, first by frightened foreigners worried of their real debt burdens skyrocketing, followed by domestic investors who see asset prices falling, will experience the paradoxical phenomenon of their currencies rising. Paying back debt, defaulting on debt and saving are all theoretically synonymous. They are expressed the same way even though they appear characteristically opposite.

The currencies that will experience the most of this deflation are those which have the highest ratio of debt:money, for the demand for money to pay back the debt will be highest. Naturally, the currency that was granted "reserve status" was the one which had inflated credit the most during the boom and subsequently exported it to the world. It is for precisely this reason that Charles A Conant tirelessly agitated for American economic imperialism around the turn of the 20th C. And it is for precisely this reason that Montagu Norman did the same in England during the interwar period. The gold-exchange standard (not to be confused with a gold standard) that both of these men advocated, naturally collapsed due to the ever-increasing amounts of debt being sold and skepticism over the ability to repay in gold. But in the end, they both deflated relative to other currencies (like the franc, lira, mark, peso, etc).

This is the incentive for having a dollar reserve currency. They can issue as much debt as they want to foreigners and reap the apparent immediate benefits of an elastic money supply (ie. permanent inflation). Yet when the time comes for those debts to be either paid off or defaulted on, the lone adverse symptom (to the monetary imperialists) is an increased demand for dollars either via bank loan/loss additions or foreign exchange transactions.

This is where, it appears, the "hyperinflationist camp" seem to be missing the boat. They see the public debt owned by China, Japan, etc as looming supply, ready to be repatriated at any moment. Yet they ignore the many times greater private debt that is denominated in dollars, which represents looming demand for dollars and de facto looming supply of foreign currencies that need to be sold in order to pay off those debts.

To summarize, there appears to be three different types of situations present:

1) Foreign creditor nations (China, Japan, Oil exporters) who own dollar denominated public debt as currency reserves and therefore represent future demand for their own domestic currencies when the debts are repatriated to the US. The relevance of this debt is dependent on the amount of private debt denominated dollars that is in existence. For example, how many Chinese companies have obtained their financing for infrastructure projects in dollar denominated loans? Loans that are now sitting on the books of some foreign bank waiting to be paid back in dollars. The Chinese company would then have to collect its expected revenue in Yuan, convert those to dollars and pay back the debt. My question is not rhetorical. I do not have the answer, nor do I know where to find it. Perhaps such a practice is forbidden in China and only Yuan denominated debt is permitted. That would not surprise me. If this is the case, then China would appear to be facing its own deflationary pressures. But if there are private obligations outstanding in derivatives, mortgages and commercial paper that far exceed the $1.4 Trillion in US Treasury assets, then the opposite force should prove superior.

2) Foreign debtor nations (Latvia, Mexico, Hungary, Poland and dozens of others) who thought it more prudent to borrow money in foreign currencies because they either thought their own currencies would rise, or because obtaining a loan at a low rate of interest was far easier in Dollars or Euros than in their own domestic currencies. The collapsing export markets of these countries is putting massive pressure on government budgets and the perceived risk of insolvency is, in turn, putting downward pressure on the domestic currencies, and an increase on domestic borrowing rates. The accompanying skyrocketing unemployment and rising interest rates puts downward pressure on asset prices even while the currency inflates. This panics borrowers of foreign currency at both ends - 1) their purchasing power is falling and 2) their debt/equity ratio is getting smashed. The panicky borrowers in these countries will either a) scramble to pay back the debt, requiring the sale of their domestic currency and the purchase of the foreign currency in forex markets or b) default on the debt, pressuring domestic asset prices and requiring foreign lenders to boost loan/loss reserves. Both outcomes perpetuate the problem.

3) Imperial debtor nations (US, EU, UK, Switzerland) which have large public deficits which are visible, but have enormous private banks that act as creditors to developing nations. As mentioned above, the foreign private outstanding credit likely outsizes the public debt by a considerable margin. And that does not include derivative contracts which are a total wildcard. This private outstanding debt represents future demand for dollars/euros/pounds in the forex markets. In the event that it is defaulted on, the losses will either have to be monetized (which is contingent on an appetite for debt and the political ability to do it) or realized via balance sheet deleveraging to free up capital for loan/loss reserves. The case of the former is neutral to the total supply of money/credit, the latter is obviously very deflationary. The deflationary impact could be heightened in the event that one of these imperial debtors were to default on their public debt. This would decrease the looming supply of dollars/pounds further, while the private debt would still remain.

For each of the respective groups, I see no way out of the present situation. I am still trying to determine the implications for countries that don't really fit any of the descriptions (primarily Canada, Australia and New Zealand). None of these countries made much in the way of loans to foreigners, nor is much of their public debt owned by foreigners, while there was little incentive for their citizens to take out foreign denominated loans for domestic purposes.

This post has dragged on far longer than I originally intended. But perhaps my rambling will prove thought provoking enough to stimulate conversation on the matter. I scarcely have the resources at hand to try and quantify this, nor do I think that any attempts to do so would be extra-illuminating due to the lack of transparency in foreign capital flows. But I'm interested in knowing what my readers, who often prove smarter than I, think of this.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Bearer Bondgate

I have intentionally avoided the seemingly comical issue of last week's discovery of bearer bonds. You see, $137 Billion of these things are simply not supposed to exist. So when two allegedly Japanese businessmen were caught trying to cross the Italian border into Switzerland with a briefcase full of these things, the rational thing to do would be to laugh it off and stash the thought in the back of one's mind along with crop circles, ghost sightings and time travel allegations.

But it is difficult to do that when the issue refuses to die, and that further investigations point to their validity rather than the inverse.

Zero Hedge has a fairly concise summary of the 3 possibilities, which she correctly suggests are:

1) All the bonds are fake
2) Some of the bonds are fake
3) None of the bonds are fake

Of course in the case of either #2 or #3, we have a serious problem. In the case of number #1, we have a lot of unanswered questions, such as:

a) why has the issue not died yet with a simple declaration of their illegitimacy by the treasury?
b) who in their right mind would think that any bank (or any person) would accept something with such large denominations without first checking their authenticity?
c) how do you get stopped at the Swiss border? I personally have waltzed into the country unannounced on numerous occasions. The borders are unoccupied at EU crossings. The only way you could be stopped is if someone had a specific reason to stop you. And that implies that option #1 is not the case.

For those interested in learning more about this question that keeps on giving, reading the full summary from Zero Hedge, An Open Letter To Tim Geithner, shall prove intriguing.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Technical Update 22.09

It was a fairly uneventful week from a technical standpoint. Volatility is taming, volume is becoming anemic and negative divergences are deepening. That said, price (the most important arbiter) fails to indicate any intention that it wants to correct. Typically, markets that don't want to go down resolve upwards. And "overbought" conditions can either work their way off via time or price.

In other words, one could interpret the information as bullish or bearish depending on their perspective.

A number of weeks ago I outlined a few of clumps of technical resistance that one could use in timing the end of this rally. The first clump was in the 940-950 area (basis S&P 500). The next was sitting just above 1000. And the final levels seemed to reside around 1075-1100. One should always be wary of an irrational market to persist longer than initially believed possible. And it should also be mentioned that corrective waves have a tendency to last a minimum of 1/3 the duration of the preceding secular trend. Marking the beginning of the trend as Oct of 2007, the first wave lower was 17 months in duration, meaning that this corrective rally should last at least into the end of the summer. Sharp pullbacks, however, can easily interrupt this path. And that is my primary expectation - that we see a sharp pullback of 10-20% in the near term, followed by a late summer challenge of, and perhaps exceeding of, the recent highs (S&P 956).

It is possible, though, to mark the "beginning of the nightmare" as May of '08 if looked at in real dollar terms. The May highs came very close to matching (and for some indices exceeded) the highs of October '07, when normalized for the dollar's coincident collapse during this period. In this case, the decline lasted only 9.5 months (42 weeks) and our current rally (of 14 weeks) makes for a precise 1/3 retracement in terms of duration. As I mentioned, one can always manipulate the data in favour of their prevailing opinion and one must be aware of the "confirmation bias" that this sort of analysis can provide.



Perhaps most concerning for the bullish case, is the persistence of negative divergences in market internals. Advance/Decline ratios, volume, RSI and the number of stocks above their 50 day MA are all displaying weaker numbers than they were in early May when the S&P was a full 4% lower than last week's highs.

The 50 day MA of Advance/Decline stocks is below.


One would surmise that amid all of the talk of "green shoots" in the housing market that the homebuilders would be displaying strong characteristics considering that they were the sector most heavily hit in '08. However, upon further review we see that the hommies are displaying relative weakness over the last 6 weeks. If we were to believe the pollyannas in the media that an economic recovery was imminent, residential investment is one of the leading indicators to be watching - and this would be visible in the homebuilder stocks. This is not the case.



And pray tell, what is one to make of the continuing non-confirmation of perhaps the most important sector any recovery would be dependent on? I'm obviously referring to the banking sector. Without an organic recovery, which would obviously take years to liquidate, reallocate funds and begin production, the only hope for the middle part of a "W" shaped recovery would be a continuation of the insane lending practices of the middle part of this decade. If this lending were indeed taking place and it was perceived to be profitable for the banking industry, bank shares should be massively outperforming the major indices. Again, not the case.



In conclusion, I do not find it difficult to conceive of enough reasons to believe that the present rally is over, or at least poised for a very sharp correction in the near term. However, we should not forget that the specter of quarter-end looms and performance anxiety of major fund managers is a force to be reckoned with. This could easily push the aforementioned divergences to new extremes as managers tinker with their portfolios, playing to their fairly P.O'd client base. That is, managers may decide to switch out of underperforming sectors into the outperforming in order to make themselves "look smart" when the time comes for them to begin writing "Dear Investor" letters.

I'm officially on the fence. I've allocated 50% of my intended capital to short positions and will add the other half at higher prices or not at all. Do note that this is not an explicit recommendation to get short. For those interested, my preferred vehicle for shorting is LEAP PUTS with a Dec '10 expiry on the S&P. This gives me more than enough time to realize my expectation. After learning the hard way in '07 that a market can climb a "wall of worry," the time premium is a price I'm willing to pay. Just thought I would share.

Have a great week!

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Of Pitchforks and Torches

For those that follow the socionomic principle that social mood is causal, rather than consequential of social action (personified by the buying and selling of stock, willingness to take credit risk, consumer time preferences, etc), some of this weeks headlines should be of interest.

It is often found that financial crises and the uncovering of fraud tend to often coincide. This does not mean, however, that the fraud in question is some shocking revelation, only discovered by the work of a heroic detective. To the contrary. More often than not, the specific fraud was well known for years, even decades, before it became an issue of public outrage. So it is not necessarily the precise nature of whatever fraud has been exposed that is of concern to us. Rather it is the social reaction to it that provides clues to the overall state of social mood, and therefore to potential repercussions this may have for the financial markets.

Social mood was ambiguous to fraud in our financial markets in recent decades. Even the high-profile cases we are all familiar with (Enron, WorldCom, Barings Bank, etc) were mere blips on the radar. The stock market barely reacted. People didn't really care. And unless they were holders of those particular companies' stock, most people's net worth was higher 6 months later. Unemployment was low, wages were rising and they could obtain a mortgage by fogging a mirror. They felt better off. So why complain?

Such is not the case today. Even with a 45% rally in the stock market off the March lows, the average person is still invariably worse off than they were six months ago. And much worse off than they were a year ago. Those who are lucky enough to still have a job see their wages falling or overtime being slashed. Their home's market value is still falling. And the only saving grace of last year - falling mortgage rates and gasoline prices - are now rising again. They are being squeezed at both ends.

So it is only natural that closer scrutiny is paid to those who can be blamed for their plight.

Ron Paul's Federal Reserve Transparency act (HR 1207) appears to be one such manifestation of the common anger. Of course, the Federal Reserve's meddling in the economy is nothing new. Dr. Paul has been warning of its interventionist economic policies since the early 70s. Entire economic schools of thought have railed against the Fed since its inception in 1913, arguing that their interventionism magnifies the business cycle, rather than smoothes it. So why is it that now, all of a sudden this bill has obtained 213 cosponsors stretching across both parties? Democratic Party skepticism of central banking is showing its first signs of life since the days of Grover Cleveland. There was no organized public outrage against the Fed after the Dot.com collapse, nor after the S&L crisis. So what has changed? Only the social willingness to go after those who can be blamed for causing the bubble.

Another revelation we have learned of is that former CEO of subprime lender Countrywide Financial, Angelo Mozilo is being charged with fraud by the SEC for insider trading and failure to disclose pertinent information to shareholders. Mozilo sold $139 million worth of stock in 2006 and 2007 while it was obvious that the subprime business model was kaput. Nevertheless, Mozilo and Countrywide continued using company profits for share buybacks - the same stock he was selling. Again, this is hardly surprising. Share buyback announcements were almost a daily occurrence in early 2007 and many of the buybacks coincided with executive exercise of stock options or outright dumping of shares. This was pointed out on numerous occasions by many market analysts and shareholder advocacy groups. Yet the cries fell on deaf ears. Until now. A pertinent snip from a MarketWatch article dated June 5th reads that the defense lawyer "...also accused the SEC of bringing the case in response to political pressure to repair its reputation, which has taken hits from the agency's failure to detect the Bernard Madoff fraud." (emphasis added)

Political motives for covering one's own tracks will likely prove to be fuel for the insatiable fire of public rage. Inquiries and fraud charges like these will in turn reveal more fraud and negligence by regulators. In the last week we have learned that another Countrywide executive, John McMurray tried to blow the whistle on the company's potential systemic risk at a conference hosted by the Federal Reserve Bank of Chicago in 2006. He was promptly ignored.

On April 15th, however, we received perhaps our most telling bit of evidence on the state of social mood. More than a million Americans participated in tax day TEA (Taxed Enough Already) Parties, expressing various grievances they have with their government's handling of the credit crisis. The second round of these events will be held on July 4th and are being organized in over 1100 US cities. Will the calls for political action add to the positive feedback cycle of seeking out scapegoats which upon new revelations further intensify public anger, calling for more inquiries, etc...?

It is more than a slight possibility that the countertrend wave of investor optimism persists for longer than most bears are able to stand, while social pessimism builds in the background. But my suspicion is that as the summer wears on, social mood will prove too much for the stock market to handle, and opportunistic traders will take their profits at the first sniff of a turnaround.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

IMF Tells Europe's Banks To Come Clean

It was only a matter of time before Europe's dirty little secret got some serious play.

Don't expect to hear any of this in the North American press. Europe may as well not exist according to them. Either that or they unquestioningly took the politically populist rhetoric that, "the whole crisis belongs to America, not Europe" far too literally.

Despite the major headwinds facing the US economy (consumer deleveraging, CRE, California, pensions, etc), the next round of panic will likely originate outside the US and subsequently magnify the aforementioned headwinds. Surely, this will provide a convenient scapegoat for the Obama Administration.

The leading candidate for such a catalyst would intuitively be the largest economy in the world. No, not the US. The European Union. As mentioned recently in Der Nächste Schuh, contrary to popular belief, the German banking system was just as irresponsible as the American. The difference was that loans were not being made to Germans, but rather to foreigners, so the effects were not as readily noticeable. But as it turns out, the Landesbanken (German state-owned banks) who's boards of directors are filled with the politically well connected, had been a dumping ground for US toxic waste - evidently the "benefactor" of German trade surpluses.

Of course, Germany wasn't alone in the mad dash to lend to foreigners. Austria is up to its eyeballs in loans made to Eastern Europe. Sweden had done the same in the Baltic States. Spain pumped money in to cajas that were used to finance a property boom fueled by foreign investors. Ireland had engaged in an Florida style construction boom as well. That is only a brief summary. In each case the circumstances are somewhat different, but the cause was readily apparent: The ECB's attempt to keep one interest rate for the entirety of Europe caused an unnatural boom in places where loose lending standards ruled. Europe's major economies footed the bill via inflation and sticky unemployment.

Now the jig is up. Spain, Ireland and the Baltic states have collapsed into depression. Their debts will never be paid. Eastern European currencies have tumbled, massively increasing their debt burden. They either hyperinflate or default. All of these loans, in addition to the tens of billions of US toxic waste remain on the balance sheets of European banks. And for the most part they are still valued at 100 cents on the dollar.

This is obviously of concern to those hoping to see recovery in the near term. The IMF considers itself among the concerned. From the Daily Telegraph:

IMF tells Europe to come clean on bank losses

"To restore confidence, you need total disclosure of possible losses," said Dominique Strauss-Kahn, the IMF's managing director. "Not only losses which are linked to the original sub-prime crisis, but also the losses linked to the slowdown in the economy, and impaired assets. There are lots of things that still have to be disclosed," he said, adding that credit mechanism remained jammed.

The latest IMF report said the chance to raise fresh bank equity while optimism lasts should be "seized without delay" and demanded a "comprehensive review to assess capital needs and viability."

"Stresses persist, conditions for access to bank lending are tight, funding costs remain high. Sizeable losses lie ahead as the recession unfolds. The financial sector is hamstrung in fulfilling its vital intermediation role."

The IMF says eurozone banks will need to raise a further $375bn (£235bn), compared to $250bn for US banks, and has called for a stress-test along the lines of the US Treasury probe.

There are widespread concerns that Germany in particular is hiding bank problems until after the September elections, using its "bad bank" scheme to keep "zombie institutions" alive.

The eurozone is not yet out of the woods, and risks sliding into a deeper downturn. "Adverse feedback loops between the financial and real sectors could trigger a protracted deflation," said the fund.

(emphasis added)

Europe's financial crisis is just getting started. Political attempts to stall the realization of these problems may be overcome by countervailing political attempts to expedite them. It's going to be a long, hot summer.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Technical Update 21.09

The market's "gap and crap" performance on Friday morning has the potential to mark a turning point. Failing to rally on "good" news was one of the characteristics I was looking for two weeks ago in More On Social Mood. The headline payroll data came in way better than expected and the market shot higher immediately following the news. Bloomberg ran the following headline: "US stock futures surge as employers cut fewer jobs than forecast." Unfortunately, something strange happened in the hours following. The market tanked. Falling from a pre-market high of 957.5 to 932.5 2 hours later.

This is not something that has happened since the rally began in early March. Good news was bought. So was bad news. Because it was "less bad" than expected. This goes to show once again that it is not the news that matters, but rather the reaction to it that counts. The same Bloomberg article had changed its title by the end of the day to, "Most US stocks fall on interest rate concern." Rates were lower than they were in the morning.

I am more confident that a top of some significance has been put in. The nature of the ensuing decline should be of interest to determine whether Friday marked "the" top. I am looking at a number of possibilities:

a) Friday marked a significant high to be retested later this summer after a large selloff
b) Friday marked "the" high, we proceed to new lows
c) Friday was only a speed bump on the way to S&P 975-1000, where a meaningful reversal takes place
d) There are obviously many other possibilities but I don't feel that they are of a high enough probability to warrant consideration

Taking a look at some of the various indices and asset classes we are seeing some important negative divergences, while heavy resistance resides above.

First is the S&P 500, now having rallied 42.9% in 13 weeks. Notice the negative divergences in volume and the RSI, while it struggles to gain the 200 day EMA. (Note: many analysts have claimed that the S&P has surpassed the 200 day. This is true for those using the "simple" moving average. I use exponential moving averages. Neither are better than the other. It is only important that one uses the same method consistently).



The Dow Transports are also putting in a non-confirmation after the Industrials surpassed the early May highs early this week. For those following Dow Theory this is a problem. Also note that it too is struggling to surpass the 200 day EMA.



The Dow Utilities are still phenomenally weak. After being sold off as aggressively as everything else (falling 48% from their highs), the sector has been the weakest on the rebound. The market is clearly sensing their vulnerability in that they are saddled with debt and will likely need to cut their dividends in order to raise capital.



The market's internals are still in overbought territory, which doesn't mean anything on its own, but combined with the above factors, one knows that the odds are not good for a continuation. At least not in any explosive manner.

Below is the percentage of NYSE stocks above their 50 day moving averages. Note that fewer stocks displayed this characteristic on last week's push as did in early May. This suggests that leadership is narrowing.


Next is the 10 day moving average of the advance/decline line. Notice how infrequently this indicator goes more than a few months at a time without at least visiting the -400 mark if not lower. The last quarter this did not happen was Q4 2006. Smack-dab in the middle of the "cinderella economy."



Oil has recorded an exact double from its lows last year. It is now in the thick of my resistance zone between 65-75.



I reinitiated my short position on the Canadian Dollar near the highs as I didn't feel comfortable without it. That was a trade I should have taken much earlier, but didn't. The US Dollar appears to have put in a reversal. Sentiment reached a negative extreme. 95% of currency traders were bearish on the Greenback. In Europe I've heard this extreme was even more pronounced, at 99%.



That's all for now.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

On Consumer Deleveraging

I think it is appropriate for us to revisit a John Kenneth Galbraith quote that I have posted before from is book, The Great Crash.

What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune.
...
The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market and who then bought common stocks, would see their value drop to a third or a fourth of the purchase price in the next twenty four months.

We often forget that the bulk of the damage done to the stock market was not done during the crash of 1929. Then, the Dow Jones lost only 49% of the total 89% it would lose. Following the crash, was a long, winding rally spanning a little over 5 months and rising 52%. Of course, history never repeats itself exactly, and therefore the exact numbers are of little use to us. But the central concept is what is important. The Dow rallied in late '29-early '30 high enough, and for long enough that it convinced nearly everybody that the worst was over and good times were soon to return.



Throughout those 5 months there are numerous hilarious quotes from some of the most respected people of the time, including Irving Fisher, Richard Whitney, and Herbert Hoover. All of them claimed that the new bull market was real and there to stay. Fisher and another legend who made a fortune being short in '29, Jesse Livermore, nearly went broke in the ensuing years. Whitney ended up in prison for embezzlement. Hoover is regarded as one of the worst presidents ever.

With that bit of historical perspective, it should probably be of great concern to investors to see how such a similar reversal in spirits has occurred over such a short period of time. Stock market bulls accounted for over 85% of traders for much of the last two weeks according to the Daily Sentiment Index - highs not reached since the Oct 2007 peaks.

As I pointed out a few weeks ago, it is very easy to see that the areas of improvement (now known widely as "green shoots") are primarily in the areas that the Fed has decided to intervene and essentially become the market. Other areas of what looks like improvement appear to be nothing other than speculation fueled by government giveaways. For example, Merrill Lynch analysts have been feverishly upgrading the REIT sector after Merrill itself underwrote billions in capital raises by those same companies. The upgrades are seen as bullish by other brokerages who themselves upgrade the stock, sending the price higher and further enabling the REIT to raise more capital via share dilution.

To be sure, this kind of activity is precisely what Geithner and Paulson had in mind when they gifted the big banks trillions of dollars - to try and reinflate the bubble. But will it "work"? No. It's like The Three Little Pigs in reverse. The Big, Bad Wolf blew down the wood house in the fall, and they have scrambled to build a straw house in its place. Building a brick house (a real economy based on savings and production) was going to take too much time, too much effort. So they built one based on speculation instead. Like all speculative bubbles, it will collapse as well. Behind the glossy surface that is easily seen, the real drivers of the economy are quietly deteriorating.

Despite the media's spin attempts, Friday's payroll data was abysmal. Gluskin Sheff's David Rosenberg had the following to say:

...the internals of today’s report, in a word, were awful. Not only are businesses still cutting jobs but they are also reducing the hours that their employees are working; the private workweek hit a new record low of 33.1 hours (from 33.2 hours in April). So, total labour input was much weaker than the headline payroll suggests and this is vividly illustrated in the aggregate-hours worked index, which fell 0.7% MoM and something ‘green shoot’ advocates will not like discuss since this was actually worse than the 0.3% MoM drop in April; this takes the three-month trend to a -8.6% annual rate. Think about that for a moment because what goes into GDP is total hours worked and productivity — so the latter better continue to hang in there or else we are going to be seeing some nasty output data going forward that may well take Mr. Market by surprise. Put another way, if companies had held hours worked constant in May instead of cutting them, to achieve the total labour input they achieved last month would have required — get this — a 927,000 payroll cut. ‘Green shoot’ indeed.

(emphasis added)

Rosenberg is focusing on the correct driver of the economy - productivity. And right now, productivity, wages and employment are still declining as if government stimulus never occurred. Brian Pretti is out this week with another comprehensive investigation. This time looking into wages and incomes. From the article:

The concept that deleveraging is a big macro construct of the moment. We see it directly at the household, corporate and financial sector levels. As a counterpoint, it’s the government who is leveraging up to try to maintain price and broader economic stability as an offset. Directly to the point, in an economy very much dependent on consumer spending, absent households releveraging their balance sheets (which is absolutely not occurring, nor will it), the character of wages, salaries and broader personal income growth becomes the key driver of a potential forward consumer spending and broader economic recovery. US economic recoveries in recent decades have shared three identical character traits – pent up demand for houses goosing purchases and ultimately new construction, pent up demand for autos goosing purchases and ultimately new production, and consumer credit balances taking off northward in an environment of renewed optimism. For now, these three character traits are missing from the broader economic equation. The deleveraging process occurring directly before our eyes at the household level tells us that the character of wages, salaries and personal income takes center stage in the potential for a consumer led US economy recovery, or not. Could this very set of facts and the eventual broader realization of these facts be the basis upon which another potential leg down in the economy and markets occurs? For now the financial markets have a head of steam. Momentum and the gravitational pull of the markets upon those underweight their asset allocation mandates is driving the short term. Important to realize just what we are looking at.

(emphasis added)

Pretti then goes on to discuss a number of different measures of the labour market accompanied by some very relevant charts. A few of them below:

First is the Employment Cost Index. This incorporates wages and benefits together. Never in the 25 years of this data have we seen incomes stagnate like they are now.



Second is a chart of personal incomes from assets including interest, dividends and rental streams. Again, never in the history of the data, this series going back 50 years, have we seen such damage being done to household balance sheets. People are experiencing net losses from their assets. (Note: the two spikes earlier this decade should likely be ignored - I don't know what would have caused those other than perhaps changes in accounting laws).



Another not so widely reported number we received on Friday was that of consumer credit. It dropped another $15.7 Billion in April to $2.52 Trillion. It was the third consecutive monthly decline. The six month average works out to a 6.6% annual decline. Again, record numbers. Below is a chart courtesy of Calculated Risk.



To get an idea of how important consumer credit has been to the economy, let us take a look at the cumulative buildup of consumer credit over the decades. Here we can see that starting in about the mid 90's, nearly $2 Trillion in consumer debt has been building up. It should go without saying that this was never sustainable. Chart courtesy of the St. Louis Fed.



The consumer is deleveraging. In some cases, it is because they have to. In other cases it is because they want to. But unfortunately, they're not doing it enough. At least not in proportion with their falling net worth. Below is another chart courtesy of David Rosenberg of Gluskin Sheff. It measures total consumer credit as a percentage of their assets. Even though consumers have been reducing their nominal debt levels, the collateral they have behind it is deteriorating faster.



So consumers, who of late account for a good 70% of the total US economy are losing jobs at a record pace, are having their wages and benefits slow to a crawl, are reducing their total indebtedness and yet are still finding themselves increasingly worse off than only a few months previous. To me, that doesn't sound like a recipe for a rebound in consumption - which by the way has turned negative for the first time in 50 years on a y/y basis. Chart courtesy Ed Harrison of Credit Writedowns.



I would like to believe that all of the above is irrelevant and that the blip in "consumer confidence" was a signal that everything is about to turn around. But the unfortunate fact remains: "What cannot go on forever won't." On Thursday we will get the Retail Sales numbers for May. They are expected to be marginally higher compared with the previous month. Even though that will register as a ~10% drop from the previous year, I have full faith in the media to spin the number as positive.

Regardless of what happens in the short term, it should be obvious that the real driver of the economy - the consumer - has reached the point of no return. They must retrench. They must deleverage and start saving. A person in risk of losing (or already lost) their job, has seen their net worth crumble in the last year and no longer has access to the debt market must massively retrench in their spending or declare bankruptcy. Both are occurring, and in record numbers.

Talk of green shoots in the midst of all this is premature. The speculative euphoria that has resulted has been breathtaking in its disregard for risk. I do not know if it will continue past the point it has already reached. But after rallying 43% in 13 weeks, I would have a hard time chasing upside from these levels.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Merkel Goes After ECB

In an unexpected turn, German Chancellor Merkel starts throwing cheap shots at the ECB, Fed.

I say "unexpected" because most people can't figure out why Merkel would target the central bank as the cause of Germany's economic problems. But in fact I wrote about this very thing back in January,

Germany has a general election later on this year. I fully expect that at some point, the issue of Germany's ties with the rest of Europe will become front and centre. The euro cannot survive without Germany's support.

Merkel is going after the ECB as a conduit to the European Union as a whole. She senses the populist anger that is rising against European integration. She sees the imminent collapse of Eastern Europe as an endless source of headaches and does not want to deal with them during an election campaign. Knowing how the German population would react to German funds flowing to the ECB and then off to places like Latvia, Merkel has decided to preemptively avert what could be a political disaster.

From the article:

Unconventional monetary policies being pursued by the world’s main central banks could aggravate rather than ease the economic crisis, Angela Merkel, Germany’s chancellor, suggested on Tuesday.

Her surprisingly strong attack on the US Federal Reserve, the Bank of England and the European Central Bank was remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition of never commenting on monetary policy.

Angela Merkel, the German chancellor, has criticised the world’s main central banks in surprisingly strong terms, suggesting that their unconventional monetary policies could fuel rather than defuse the economic crisis

“What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,” she told a conference in Berlin.

“Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds.”

She added: “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.”

Ms Merkel’s decision to ignore one of the cardinal rules of German politics – an unwritten ban on commenting on monetary policy out of respect for central bank independence – suggested Berlin is far more concerned about the ECB’s approach than has so far been apparent.

Meanwhile, Berlin is anxious that central banks will struggle to re-absorb the vast amount of liquidity they are pouring into the markets and fears the long-term inflationary potential of hyper-loose monetary policies.
(emphasis mine)

It should be clear that no further bailout money will be flowing from Germany this summer. Anyone want to bet that the French and others will continue along without them? Or will they interpret this as a snub and revert to what Europe has been historically good at: protectionism and infighting?



Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Technical Update 20.09

There will be no technical update this week. I'll have one again before the start of next week.

My apologies to regular readers.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.