Thursday, June 30, 2011

No More Training Wheels . . . For Now

Today, the Fed will end its 8-month, $600 billion experiment called QE2.  Despite what you may hear, nobody knows what will happen next week . . . nobody!

QE2 was a program whereby the Fed would buy most all (85%) of the bonds issued by the U.S. government, in order to finance our mind-numbing deficits.  In addition, it was designed to keep interest rates low, expecially for mortgage loans.  It was successful in doing this, but home sales still did not increase.  It was designed to reduce corporate borrowing costs and was successful, but business spending remains flat.  It was designed to weaken the dollar and was successful in this, as exports increased.  It was designed to pump up the stock market and was successful in this, but consumer confidence continues to fall.  It was designed to prevent deflation and was successful in this. All in all, it was a mixed success.  It certainly was not a disaster, even if commodity prices were also forced up.

Already, interest rates on Treasury bonds are inching up.  Without the Fed buying $90 billion of Treasury bonds each month, who will buy them, at such low interest rates?  This is even more true for long term or 30-year Treasury bonds, where the Fed bought virtually all the bonds.

Is the Fed finished?  No, I don't think so.  It has two mandates, i.e., control prices and drive down unemployment, and is failing in the last one.  As interest rates rise, as the cost of U.S. debt service rises, and as unemployment nags daily, the Fed cannot stop supporting the economy.  It is trying another experiment -- to see what happens in the next few weeks.  The Fed can change course quickly and return to supporting the market.  I'm sure it won't be called QE3, but it will be!

Oh, by the way, former Fed Head Alan Greenspan disagrees . . .

Special Financial Planners

Years ago, I was proud to serve as a member of U.S. Army Special Forces.  Since then, it has always amused me to see others think of us as tough, semi-savage barbarians, when we were just ordinary guys in great physical condition who were not satisfied with being merely good soldiers and wanted to be the best soldiers.

Today, I'm in Chicago attending meetings with the National Association of Personal Financial Advisors (NAPFA).  While they certainly lack the same physical conditioning, they do share that same lack of satisfaction with being merely good planners and want to be the best planners. 

They are not content to be merely certified.  They deeply want to be the best, both technically and ethically.  A little more nerdy and certainly older, I see NAPFA as the Special Forces of financial advisors, and I'm proud to be a member.

Or, maybe I'm just getting old and nerdy . . .

. . . with a tinge of guilt

At daybreak yesterday, I was getting ready for my morning run but couldn't stop watching CNBC, as the riots in Athens injured as many as 500 people, who were protesting an unemployment level twice as high as the U.S., as well as steeply higher taxes, including a 4% increase in their sales tax or VAT, along with a 15% cut in pay for public employees, which includes government, transportation, utility and telephone workers.  Deep cuts in both education and medical care will dictate the loss of even more jobs.

As I watched the Greek demonstrate their angst and fear, I also watched the futures market project higher and higher opening prices in the stock market, which means I was making money from all this.  In fairness, the market had already lost value in fear the Greek crisis would end poorly, and we just recovered some of it yesterday, but I still felt a tinge of guilt.

Today, I'm getting ready for my run and am again glued to CNBC, watching teachers and other government workers in England protesting cuts to their pension system.  Right now, futures indicate the Dow will again open up about 41 points.

It was not my fault that the Greek system of entitlements became excessive, nor the English system, nor the U.S. system.  Politicians who enabled such entitlement systems did a terrible disservice to their people, but I doubt they feel even as much guilt as I did yesterday morning.

Tuesday, June 28, 2011

Looking for Trouble . . . Or Looking for Rules?

Today, I had to fly to Chicago to attend board meetings of the NAPFA (the National Association of Personal Financial Advisors).  Waiting to remove my shoes, belt and whatever else the TSA requires, I was reminded of the Securities & Exchange Commission.  You will recall the SEC audited Bernie Madoff twice without ever discovering he was a crook.  Having been audited by the SEC, I learned there is enormous emphasis on the procedures for following rules, more emphasis on the procedures than on actually following the rules.  Protecting the public is a happy but accidental coincidence. 

The Israeli national airline has told the U.S. that our airport security spend too much time looking at things, instead of looking at people.  After two small children set off the metal detector today, I watched them being led away with their mother for more security checks.  I recalled the recent case of the 95-year-old lady, who was confined to a wheelchair, but still had to have her diaper checked and changed before boarding.

While there is undoubtedly some truth to the Israeli advice, my suspicion is that the TSA is more concerned with regulation and procedure than actually looking for dangerous people  We are so afraid of racial profiling that we prefer invasive procedures over intelligent selective protection. 

If rules matter more than outcomes, I wouldn't complain, but countless airport screening tests have shown countless guns and other weapons actually taken on board, despite the current system of checking procedures instead of checking people.

But, is there anything we can learn from the Israelis?  After all, they have not had a hijacking or terrorist attackes in over forty years.  Anything at all?

Paging Pollyanna . . .

Maybe, the wall of worry or the wall of uncertainty that is retarding Wall Street is coming down?

First, I've found it odd that Europe has suddenly become so agreeable to saving Greece over the past few days.  Then, I realized the Chinese Prime Minister was visiting in Europe.  What a coincidence?  Like any good fund manager, he has come to Europe to take advantage of cheap distressed sale prices there.  Saving Europe would not be a stretch for China, which has over $3 TRILLION in reserves.  He may pledge to buy some Greek bonds or even buy some existing credit default swaps, thereby secretly absorbing some of the credit risk.  Or, he may agree to inject capital into European banks.  There are many things the Chinese can do to "fix" Greece, but what will they want in return?

Second, with QE2 ending this week, the bond markets are holding their breath.  What will happen at the Treasury auction?  Will interest rates rise slowly or quickly?  Is the stock market dependent on the easy money of QE2?  One way or the other, that uncertainty is going away very soon.  And, don't forget, the Fed can change their mind instantly and begin QE3 if necessary.

Third, despite all the theatrics and name-calling, real progress is being made on the debt ceiling/budget cutting negotiations.  While I am adamant the debt ceiling increase should not be connected to the budget negotiations, I am more optimistic about the debt ceiling.

Don't forget that the Treasury has no resposibility to pay bondholders last.  In fact, they have a contractual responsibility to pay bondholders first.  If I were the politician in charge, I would continue paying the bondholders and quit paying Social Security recipients.  The riots in Greece are nothing compared to what happens here if the Republicans don't raise the debt ceiling.  I don't believe that catastrophe will occur, which reduces uncertainty.

Also, I am more optimistic about the budget negotiations.  The question is no longer whether to cut spending or not.  The question is how fast.  Already, both sides agree on cutting the defense budget.  Already, both sides have agreed on $2 trillion in spending cuts over the next ten years.  Already, both sides have agreed that no tax rates would be increased, instead fighting over tax giveaways to oil companies, certain deductions for the rich and some business deductions.  Again, uncertainty is reduced.

Once that wall of uncertainty reaches a certain point, the bull market will return, but we're not there yet. 

Sunday, June 26, 2011

A Real Inconvenient Truth

The last time our nation enjoyed a budget surplus was under President Bill Clinton, a fact that Democrats find convenient to remind us of frequently.  Still, the former President has written an important article in the current (June 27) issue of Newsweek magazine, where he lists fourteen ways to create jobs in America.  Some are legitimate and worthy of immediate implementation.  But, some of his ideas suggest that he doesn't recognize the new reality that governing with debt is like playing baseball in a straight-jacket.

He said "we could put a million people to work retrofitting buildings all over America."  Undoubtedly, he is right, and the WPA projects during the Great Depression were also great job creaters as well.  I wish we could take Clinton's advice now, but the U.S. can no longer afford his advice.   We could have taken his advice when America had relatively little debt but cannot afford that now.

His article reflects his Keynesian thinking, i.e., that governments should stimulate the economy to get out of recessions.  Like most Keynesians, he forgets that Keynes was a strong believer in balancing the budget over the economic cycle.  In other words, Keynes advocated running a suplus during good years and reducing debt, as President Clinton actually did.

But, after a decade of fighting two expensive faraway wars, after a huge unfunded prescription drug program, after two tax cuts, along with an aging population consuming more Social Security and Medicare dollars of taxpayers, we have forfeited any legitimate right to use half of Keynes' argument to use deficit spending to get us out of this mess.

Obama's stimulus plan delayed the inevitable loss of many jobs, such as teachers and police officers, but created very few jobs.  No additional stimulus by using borrowed money is available to us now, either financially or politically.  While there are reasonable economic reasons to reduce corporate tax levels now, it makes zero sense to give high-income earners another tax break.  It is time for Austrian economics, which means austerity for those who can least afford it . . . a morally uncomfortable and inconvenient truth.

Saturday, June 25, 2011

Who Said Economics is Dull?

Many readers have told me they read this blog primarily because it tries to make economics less boring and more relevant.  I hope so, but confess I have now found the ultimate website for that and will henceforth refer those who want to learn economics without falling asleep.  It is . . . enjoy!

Do I See Some Light??

Yesterday, the Comptroller of the Currency announced that, for the first time in three years, the banks have eased up on their strict lending criteria.  Of course, that was only for large, commercial firms but is still an improvement.

Much criticised for their lack of lending, the bankers have said nobody wanted to borrow, as potential borrowers couldn't find any business need to borrow.  Certainly, there is some truth to this.  But, there is a great deal of anecdotal evidence that small businesses have not been able to borrow any amount for any reason for a long time.

However, maybe more borrowers want to borrow AND bankers actually want to make loans again?  If so, we can begin a REAL economic recovery . . . finally!

Next Week . . . More Rolaids

During seven of the last eight weeks, the stock market has been down.  It has been a relatively steady decline, with a few stomach-wrenching days.  You might use the weekend to load up on more Rolaids.

But, I think we could be approaching the bottom, because uncertainty is getting so high.  In addition to the minute-by-minute unfolding of the Greek tragedy, this week will be the end of QE2, when the Treasury will have to actually start SELLING bonds to cover the deficit . . . to somebody other than the Fed.  There are lots of opinions, but nobody knows what will happen.

Plus, we are fast approaching resolution of the uncertainty about the debt ceiling.  While it is an unnecessarily dangerous method to deal with the budget problem simultaneously, it may have the benefit of resolving both problems simultaneously.  At that point, uncertainty will be reduced enough for the stock market to function again!

If the Greek contagion is contained, if the Treasury market survives the death of QE2, if the debt ceiling is raised before the last minute, and if there is believable progress reducing the budget deficit, you can throw away the Rolaids and celebrate the return of the bull market at a Mexican restaurant!  All four "ifs" are coming up in the very near future . . . finally, resolution is coming . . . party, party!

Friday, June 24, 2011

Tapping the Strategic Oil Reserve

Yesterday's announcement that the U.S. would contribute 30 million barrels from its Strategic Oil Reserve to match the release by the International Energy Agency was a shocker indeed.  It made no sense from an energy standpoint.  Originally established in response to the Arab oil embargo of 1973-4, there was no threat to our energy independence.  It was lamely argued that this release, less than two days of actual usage, would replace the loss of oil exports from Libya and would punish OPEC for their refusal last month to replace Libya's oil exports by increasing their production.  Maybe . . .

Partisans lamely argued that this release was motivated by political posturing of the Obama Administration to earn "brownie points" with voters for temporarily lowering the price of gas at the pump.  Maybe . . .

I suspect it may be more an act of economic desperation than political posturing.  Without pumping up the economy, it is highly unlikely that Obama can be re-elected.  The Fed is ending QE2 this month and offers no new monetary tools to pump up the economy.  Congress is completely impotent and can offer no new fiscal tools to pump up the economy.  So, what other tools are available?

When we have to use energy policy as the primary tool in economic policy, we are indeed desperate.  It is like sending a kickboxer to a gunfight.  Since our energy policy over the last forty years has not found any way to make us energy-independent, this may be its only use. 

Those who advocate a pure laissez-faire government apparently now have it.

Thursday, June 23, 2011

Fed versus FedEx

Yesterday, the Fed announced they have lowered their estimate of GDP growth this year from their 3.9% estimate in January and 3.5% in April to only 2.9% now.  They also lowered their estimate of next year's growth from 4% to 3.7%.  It is not a pretty picture.  They blamed "transitory" factors, such as the Japan tragedy and the "Arab Spring."

The same day, Fedex announced its profits had jumped 33%.  Their forecast of GDP growth in the U.S. is only 2.5% this year and 3.0% next year, which is lower than the Fed.  So, where did Fedex get their 6% increase in shipping volume?  From the emerging markets, of course!

The good news is that Fedex and the Fed agree that the second half of this year will be better than the first half!
Is there a lesson in this?  Yes, the more pessimistic economists at Fedex are probably correct.  Also, like a broken record, continue to look for opportunities abroad in less hidebound countries!

"just budgetary matters" . . . matter!

"The price for the war in Afghanistan was paid on 9-11.  Everything else are just budgetary matters."  That was the comment by a young soldier in Afghanistan yesterday, after hearing of the Obama's decision to begin a modest withdrawal of troops.

That comment bothered me.  Does that mean Social Security, Medicare, and Medicaid are also "just budgetary matters" and therefore beyond questions about the value and efficiency of the dollars spent?  If budgetary matters don't matter, does that mean the Chinese will continue loaning us money forever to fight faraway wars that benefit them?  Are there no geo-political consequences to budgetary matters?  Is there no consequence to owing so much money to the Chinese . . . or to future generations?  Are there no moral implications?

As indicated by my military record, I yield to no one in my patriotism or my love for this country.  I was in Washingtion on 9-11 and watched the Pentagon burn.  My wife was downwind and inhaled its smoke.  I know the price we paid, but it is NOT unpatriotic to actually understand the consequences of "just budgetary matters!"

Wednesday, June 22, 2011

Bad Day To Be Bernanke

From 9AM to 10AM each day, CNBC has a program called "Squawk on the Street" that usually conducts some unscientific viewer poll.  Very often, the subject is trivia.  Today, they asked viewers to call in to vote whether they felt the Chairman of the U.S. Federal Reserve System was doing a competent job or not.  They had a record number of calls, with an amazing 98% saying Bernanke was not doing a competent job.

At 2:15 this afternoon, Bernanke held his second press conference, taking unscripted questions from reporters.  When he started talking, the stock market was flat.  Immediately, it started leaking slowly, the Dow losing 80 points by the 4PM close.  That would be billions of dollars of lost value in the stock market.

All we heard was that growth is less than the Fed originally expected, that inflation is worse, that QE2 will end this month, that there are no plans for QE3, and that Greece is important.  Of course, we already knew all that, but the stock market still lost value because he confirmed what we already knew.

Maybe, he wouldn't get a 98% disapproval rating if he told us something we didn't know?

Frankly, I'm among the 2% who think he has done a credible job of staving off a possible depression in 2008, as well as deflation in 2010.  While it can be fun to dis-respect the powerful, especially with the benefit of hindsight, Bernanke utilized monetary tools that most economists barely knew about, and he did it in an uncertain market with conflicting data.  Personally, I think he deserves a raise!

The Little Engine That Could . . . Not . . . Yet!

The stock market has closed up for four straight days and six out of the last seven days.  It is trying hard to rally, which does reflect strong underlying strength.  But, the little engine, that the stock market has found, will not be enough to overcome the proverbial "wall of uncertainty" . . . that is just so high right now. 

A normal wall of uncertainty might sound like (1) what will quarterly earnings be next quarter or (2) will the Fed raise interest rates at the next meeting or (3) will Congress pass some relatively insignificant legislation?

Today, the wall of uncertainty includes (1) will the U.S. default on its debt for the first time or (2) will the Fed stop supporting the economy next month or (3) will the Euro-zone even survive or (4) can Congress do anything useful, anything at all or (5) will derivatives create yet another financial crisis?

I wish the little engine luck but think it needs to lower that wall of uncertainty by reducing the number and gravity of the questions!  Eventually, the little engine will prevail . . . but not before the Fall, at the earliest.  Be patient!  Good days are coming, but not yet.

Monday, June 20, 2011

Politics First, Economics Second

Last Friday, on a day of high quarterly uncertainty, the market closed up, largely because of comments out of the EU that they were close to a deal on Greece.  However, over the weekend, it was announced that the decision would be delayed.  As a result, futures indicate the Dow will drop about 60 points at the open.

Ostensibly, the delay is to allow time for the German politicians to explain to the hard-working, long-working Germans why they need to spend even more money to protect the early-retiring, over-benefited Greeks, which is certainly a tough sell.

The truth is that the EU wanted to help the Greek prime minister survive a no-confidence vote tomorrow.  It will be very bad indeed if he doesn't survive.  His opponent will likely reject further austerity measures, which are already painful, and the EU will walk away from further bailouts.  As much as I hate to admit it, it is a logical negotiating strategy, but investors will pay the price of delay . . . at least for today and tomorrow.

Sunday, June 19, 2011

An Austrian in Australia

Austrian economics is often called "tough love" economics, due to its hard focus on balancing the government budget and minimizing national debt.  Early advocates like Ludwig von Mises lived in Austria or Germany.  Many are also "gold bugs," believing that the yellow metal can control government spending better than legislators can.  An example would be Ron Paul.

While nearly all advocates of Austrian economics tend to be Republicans, please note there is no religious conviction that all tax cuts generate more revenue.  In other words, Austrian economics should not be confused with Supply-side economics.  It is a major philosophical disagreement within the Republican party.  You won't see the Austrians advocating a tax cut, not with the current level of debt.

One of my favorite observers of the world's economic condition is William A. M. Buckler, who writes an insightful newsletter from faraway Australia (not Austria) called The Privateer.  In his current issue, he brilliantly reduced a overwhelming maze of numbers down to a mere four.

In the last 100 years, the population of the U.S. has increased 3.35 times, while government spending has increased 5,400 times and our debt has increased 37,000 times.  Yes, you can memorize four numbers.

Of course, other types of economists will quibble about the numbers, but the wildly disproportionate increase in the role of government will change very little.  They will also argue that there is now more for the government to do, which is probably true.  But the growth of government spending is still decidedly ominous.  Buckler did not detail how much of that increase is due to entitlements, but I suspect that it was the majority. 

I don't think I would enjoy having dinner with somebody as dour and pessimistic as Buckler but do greatly appreciate his insights into our global economy.

Saturday, June 18, 2011

Thoughts From the Vampire Squid

Described as "the giant vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money," the legendary investment firm of Goldman Sachs still deserves respect for their analytical capabilities, which is so necessary to smell money.

Yesterday, they lowered their estimate of second quarter GDP growth from 3% to 2%, although they expect 2012 to see 3.2% growth.  In addition, they believe home pricess have another 5% to decline, which would be a blessing if that is the bottom.  Importantly for the President, Goldman thinks that unemployment will still be 8.3% at the end of the 2012.  (No president has ever been re-elected when unemployment was that high.)

They had been predicting the S&P would end this year at 1500 but have lowed that to 1450, which is still a 14% increase over the current level.  Gold will increase 10% by the end of next year.  The dollar will continue to appreciate against the Euro but depreciate against the Yen.  Yields on ten-year Treasury bonds will rise from 3% to 3.75% by year-end 2011 and 4.25% by year-end 2012.

Overall, they agree that this recovery is long and slow, that there is no "double-dip" recession, that interest rates will rise, and that commodities will continue to increase (including gold and oil).  Of course, long-time readers will recognize most all of this.

One big difference is that they express no fear of  the impact of a derivatives failure.  Oh . . . that's right . . . Goldman Sachs is one of the world's biggest dealers in derivatives . . . maybe, that's their "blood funnel?"

Friday, June 17, 2011

Just a Reminder . . .

Investors buy companies or sectors they believe are positioned to perform well over the foreseeable future.  Traders buy or sell anything that might change in value over the next day or so.  Investors take little risk over a weekend, when the stock markets are closed.  Traders take much risk over weekends, when politicians can make news (think Greece).  To prevent being stuck in something that is losing value over a weekend, traders often sell everything on Friday afternoons, so they can be all-cash over the weekend.  That is the primary reason that Friday afternoons are the most volatile day of the week.

Today is not only a Friday, it is also an expirations Friday, when many derivatives rollover and reset.  It is called Quadruple Witching and adds even more volatility.  (If there is a derivatives failure, as I have feared for some time, it most likely will come on a Quadruple Witching Day!)  As if all that wasn't enough, it is S&P Rebalancing day.  Plus, the market has experienced a large number of days recently with 1% moves up or down, indicating some instability, which is somewhat worrisome.

At this time, the futures market indicates a 80 point increase in the Dow when it opens at 9:30AM.  So, expect volatility today, but don't be concerned with whatever happens.  We normally study market closes everyday but NOT today.  You shouldn't either.

Thursday, June 16, 2011

Picking My Friends . . . and others too!

Earlier today, I admitted to agreeing with Karl Marx about one thing.  Don't tell anybody, but I also agree with George Soros on one thing, i.e., that economics has been crippled by a dependency on quantitative methods.

A few years ago, a brilliant mathematician named Nassim Nicholas Taleb, who has the warmth of a Brillo-pad, wrote "The Black Swan."  He believes that highly improbable events do take place.  The common characteristics include (1) the event is completely unexpected, (2) after it begins, it is worse than it looks then, and (3) everybody will agree afterwards that it was all foreseeable. 

Today, Taleb is an advisor to a European fund that has just announced that another Black Swan event is about to occur.  The humor is that they use math to support their prediction.  By definition, if it can be predicted, it is not a Black Swan event.  Besides, I think George Soros is right that such predictions, depending on math, are inherently untrustworthy.

If the European Union comes apart, if the U.S. defaults on its debt, and if we really need QE3, then we could have a really ugly market collapse, and we'll just call it a Black Swan event.  But, I'm not losing any sleep over all this.

Preparing for Greed

During the Spring, I became very concerned about the stock market.  (Very concerned, not scared!)  I predicted it would be an ugly summer, and it has been so far.  The market has dropped about 7%, not quite a technical correction, which is a 10% drop, but we are still falling.  Last year, we dropped almost 16% before rebounding nicely.  A 20% drop is usually called a bear market.  We didn't get there last year, and I don't expect we'll get there this year either.

Once we get the debt ceiling increase behind us, once we get some calm in the European debt crisis, once we manage our fear about China's possible recession, and once we know there is life after QE2, it will be time to get greedy again and start buying.  I still think the year-end will be good and am wondering when the market will hit the bottom this fall.  We'll see . . .

The Elastic Knowledge Gap

You can imagine a large table in a plush government conference room surrounded by a bunch of smug economic advisors and frightened political leaders, facing the grim reality of what the nation needs to do, i.e., austerity.

Outside, thousands of people are protesting this grim reality.  They never had a course in economics, because they never had a requirement to learn such things.  There will always be a difference in the level of knowledge between the two groups, which is normally fine.  But, when the knowledge gap becomes too great and the people are expected to suffer higher unemployment, higher inflation, reduced health care, and reduced pensions, the people will naturally take to the streets.

While this is understandable, it is not helpful.  The cost of living beyond means must be paid.  The only thing Karl Marx ever said that I agree with is that . . . the sins of management are visited upon the workers.  Another version could be that the sins of political leaders are visited upon the people.  But, how can the people recognize the sins of political leaders if there is no economic education?

Closing the knowledge gap will reduce the protests, but it is already too late in Greece.  Maybe, it is not too late in the U.S.??

Wednesday, June 15, 2011

A Double-Dip . . . Again?

Every time the market gets bearish, pundits begin fretting about a "double-dip" or return of the recession.  While anything is always possible, it is unlikely.  I have argued for almost three years that a financial crisis is very different from any garden-variety recession. 

There has been some impressive research by Ken Rogoff of Harvard whose "research also shows that following financial crises, economies tend to grow only fitfully."  In other words, there is no sharp recovery, like we enjoy from "inventory-correction recessions" or "shock-induced recessions."  It is long, painful, and irregular.  That's why our unemployment remains so stubbornly high. 

Of course, if we were to sustain a shock at this time in our long, slow, and vulnerable recovery, we could fall back into recession.  That's why I carefully watch (1) the debt ceiling, (2) the Chinese economic engine, (3) the price of oil and (4) Europe, of course. 

The budget wrangling over the debt ceiling really is debilitating the market.  There is already a budgetary process that allows us to be disagreeable with each other, without involving and roiling the international credit markets.  It is like inviting your mother-in-law into an argument with your spouse!

With the fear of becoming a "broken record," I still believe that a major derivatives failure could cause another financial crisis and take us back to March of 2009.  The few new regulations to control this risk were supposed to take effect next month but have been delayed until year-end.  The regulations were minimal, focused primarily on disclosure about the size of the $600 trillion market.  The lobbyists were successful by limiting the regulation to begin with and successful again by delaying, if not killing, the implementation.  For example, who knows who gets hurt from credit default swaps on Greek bonds?  The problem is that nobody knows, so how do you avoid those banks who could get hurt?

Is it time to panic?  Of course not!  If the debt ceiling is not raised before the August 2nd deadline, I would consider panicking.  If there is a major derivatives failure, I would consider panicking.  A failure of the Chinese economy or a crippling spike in oil would not cause me to panic.

It is summer . . . go to the beach!  Long time readers will know what I'm watching. . . .

Tuesday, June 14, 2011

On The Republican Debate

Actually, it was more of a spinning contest than a debate.  It was a spinning contest between the purists and the realists.  The purists believe that every rich person actually produces jobs for poor people, while the realists believe people are complicated, basing their decisions on many factors, including taxes.

It would be no different in a Democratic debate.  There, it would be a spinning contest between the extremists and the moderates.  The extremists believe the government can never do too much for that noble creature called mankind.  The moderates believe people are complicated and no one government solution will ever work.

I would like to see a real debate between the Republican realists and the Democratic moderates.  They could fashion compromises to make America the economic engine of the world once again. 

I would not like to see the Republican purists and the Democratic extremists in the same room for any reason, as they would be talking PAST each other, instead of TO each other.  They would be condescending and insulting to each other.  They would be wasting my time.  Please don't let them waste your time!  You need to be studying the stock market instead . . .

Assume your candidate wins, how would that impact your investment strategy?  Now assume the candidate you fear the most wins, how would that impact your investment strategy?  Most investors over-react to both scenarios, but it is still worth thinking about.  You'll probably wind up somewhere between the two.

Honey . . . I Forgot the Engine!

For most of my life, the U.S. has been the engine for world economic growth.  For a time in the 90's, it was thought that the new European Union would take our place, and they almost did.  Yet, we were finally displaced by China and other emerging markets during the last decade, when they routinely experienced better than 10% annual growth in GDP.

Now, things are looking much more grim for China.  Inflation has broken out badly.  The stated rate is 5.5% but is actually much higher.  GDP growth was "only" 9.7% during the first quarter this year.  There have been an unprecedented number of public demonstrations and even riots this year, protesting the lack of jobs, as well as the high cost of housing, food, and fuel.  The Chinese government invariably over-reacts, especially in light of the Arab Spring this year.

To cool off their inflation rate, the Chinese are raising interest rates, with another rise expected next week.  They need less growth, not more.  This is the opportune time for them to let the Yuan slowly increase, and they have been. 

Another way to view this is that the world's economic engine is slowing down, something a world recovering from the worst recession since the Great Depression can not afford.  Without the U.S., without Europe, and without China, who will become the essential engine to drive world growth?

There are other BRIC nations, i.e., Brazil, Russia, and India.  Brazil is the best bet, but they have instituted capital controls to slow down their growth as well.  Russia is a one-horse economy, dependent upon oil.  India is rapidly becoming as politically dysfunctional as Japan and the U.S.

Maybe, the engine will not be a nation but an economic sector.  The President hopes it will be "green energy."  That would be fine.  The world economy just needs an engine. Almost any engine will do!  Even a VW engine looks pretty good in a BMW . . . that has no engine.

Saturday, June 11, 2011

Thinking About the Debt Limit . . .

Between now and approximately August 2nd, there will be a great deal of discussion, if not debate, about the Federal debt limit.  As you think about it, please visit frequently.

We tend to focus on the horrifying grand total at the top of the page, but please notice the components of it.  For example, it is interesting that some Personal Debt is decreasing.  People are paying down their debt, which is a good thing in the long run but a bad thing in the short run, because people are not using their money to buy "stuff." 

The government must do what families are already doing.  (Of course, families can actually make decisions.)  Unfortunately, that will also slow down the recovery . . . but essential anyway.

I'm also concerned that Small Business Assets are decreasing, while Corporation Assets are decreasing.  We know where jobs are produced and think a NASA-style program to help small business should be considered.

However, the scariest number is U.S. Unfunded Liabilities at the bottom . . . yes, that's $114 TRILLION!

Friday, June 10, 2011

Grasping at the Export Straw

Yesterday was a good day in the stock market with the Dow closing up 75 points.  That was because something unusual happened . . . we got some good economic news, i.e., our trade deficit narrowed to only $43 billion.  Politicians and voters bemoan the falling dollar, but it is good for business!  It makes imports to us more expensive (therefore, we buy less from foreigners), and it makes our exports cheaper to foreigners (therefore, they buy more from us).

In fairness, some of the decline in imports from Japan was due to their inability to produce things we normally import, due to their tragedies, but most of it was due to the falling dollar.

It is in the best interest of politicians to talk about "King Dollar," while they do everything they can to de-value the dollar.  To do so, you run a big deficit, increase money supply, and keep interest rates low.  Of course, devaluing a nation's currency is only a short term solution.  At some point, the currency becomes worthless unless you balance the budget, increase money supply at the same rate as GDP growth, and let the market set interest rates.

Today, there hasn't been any good news, and the market is drifting down, as I expect it will over the next few months.  Take the summer off, and don't be grasping at any straws.

Thursday, June 9, 2011

A Crack in the Facade?

CNBC usually has a quick online survey each morning.  Today, they asked what we thought we would see first, the Dow back up to 13,000 or gas at $5 per gallon.  58% believed we will see gas prices go back up before the Dow does.  It makes you wonder if they know what happened at yesterday's OPEC meeting, which the Saudi ambassador described as the worst ever meeting.  It was the first time in twenty years that they were divided, especially bitterly divided, as they are now.

The Saudis wanted to increase production, to lower the price of oil and to support the anemic world economies.  Saudi Arabia has the capacity to produce more oil.  Most other nations, like Iran and Venezuela, are producing as much oil as they can.  Therefore, they want to keep the price as high as possible.  (Besides, anything that hurts the U.S. must be a good thing, to their way of thinking.)

The Saudis walked out disappointed, promising to increase their own production, regardless of the rest of OPEC. At first thought, anything that reduces the monopolistic power of OPEC cannot be a bad thing!  One can only hope this is a permanent change.  Secondly, with the Saudis promise to increase oil production enough to reduce prices at the pump, why did 58% of the CNBC viewers think we'd see $5 gas before we see a 13,000 point Dow?

Saudi Arabia produces primarily heavy crude, not the light, sweet crude needed for gasoline.  They produce the wrong type of oil for your car to use. 

Given that I'm bearish on the stock market for the next few months, the CNBC viewers are likely to be correct, darn it!

Wednesday, June 8, 2011

Closing the Candy Store

Yesterday, the Dow was up 60-80 points all day, expecting to hear good news when Fed Head Ben Bernanke spoke at 3:45 PM.  As he started to speak, the stock market started to drop, finally losing 19 points for the day.  So, what happened?  What did he say?

First, he confirmed the U.S. economy has slowed down.  Did anybody not already know that?

Second, he confirmed that QE2 would end this month.  While everybody also knew that, the market was hoping for more, to maintain its current "sugar high".  Analysts and pundits publicly agree that quantitative easing must end, but privately are afraid of what happens then.

Third, he confirmed interest rates would remain low.  That might be a little "newsy," because the European Central Banks is expected to raise interest rates in Europe soon, perhaps as early as Thursday.  This should cause the dollar to lose value against the Euro.  This is good for the U.S. and bad for Europe, where the expensive Euro is hurting their exports badly.

So, why did the Dow lose almost 100 points during the day?  Because speculators were betting on QE3.  That's all . . . just betting . . . not investing.  If Bernanke had said they were considering another round of quantitative easing, the stock market would have jumped, and the speculators would have profited.  They ignored the expected benefits from a falling dollar, focusing on the 'sugar" of quantitative easing.

As much as I hate the confusion caused by speculators, they do provide additional liquidity to the market.    Unfortunately, Bernanke has no control over them.  He was doing his job, trying to keep the economy moving and the market informed.  The speculators were doing their job, making bets.  And, investors got whip-sawed . . . again.

Tuesday, June 7, 2011

OK . . . I Apologize!

My mother always warned me not to be such a big man that I cannot apologize, so I apologize to Treasury Secretary Timothy Geithner.

I have long held the belief the economy was on a slow but sustainable path to recovery, unless we have another "heart attack," which will happen in the financial sector when (not if) there is a major derivatives failure.  I was very critical of the Obama Adminstration, especially the Treasury Secretary, for pushing re-regulation of everything else in financial services, except one of the primary causes of the last financial crisis, i.e., derivatives.  (In fairness, I was also very critical of Congress for largely ignoring this nagging cancer of the body of our economy during the Dodd-Frank debate last year.)

Yesterday in Atlanta, Mr. Geithner finally took a stand by calling for global standards in derivatives contracts, in order to prevent a global "race to the bottom."  So, I apologize for saying he didn't understand this complex problem.

However, while he did stand up at last, he may have done it for the wrong reason, i.e., to protect the large U.S. banks who make billions of dollars structuring derivatives, rather than to protect the whole U.S. financial system.  Yet, it is a step in the right direction.

Again, there are good derivatives and bad derivatives.  But, we don't how much of either are out there, nor the terms.  It is a giant black hole of worry for me!  As a result, I generally don't like holding stocks of companies in the financial sector.

Of course, I know Secretary Geithner doesn't care if I apologized or not . . . but my mother would!

Sunday, June 5, 2011

The One-Man Fed

I just finished reading "The Panic of 1907" by the Boston Fed.  It is an interesting read of a near-collapse of the banking system . . . when there was no Federal Reserve System to save us.  It begins with the efforts of Augustus Heinze to corner the copper market.  When he failed, the savings bank he owned also fail, followed by the Mercantile National Bank, where he was President.  When the public learned Heinze was a friend of the head of Knickerbocker's Trust Company, depositers began a run on that healthy bank, demanding their deposits in cash immediately.  The headline of the Boston Globe said "Crash, Crash, Crash." 

As fear spread from one bank to the next, there was only one man who so dominated America's financial markets that he could stop the run, i.e., J. Pierpoint Morgan.  He did not benefit financially, at least directly, but only by saving the nation.  I don't know if he was a patriot, but he did save the country, as well as his own fortune.

Seeing the importance of having a bank-of-last-resort, Congress began the process of creating the Federal Reserve System, which happened on December 23, 1913.  But, could we do that today?

In the aftermath of the 1907 panic, the President was blamed, of course.  Yet, his opponent, William Jennings Bryan, defended President Theodore Roosevelt, saying "Don't blame the Sheriff, but the horse thief."  I don't recall Senator Harry Reid defending President Bush when the latest crash occurred, nor do I recall Senator Mitch McConnell defending President Obama who inherited it.

Since Pierpoint Morgan is dead and Congress could never legislate a new bank-of-last-resort, I'm thankful we have the Fed.  They are the only economic adults in Washington.

Friday, June 3, 2011

Bad Day To Be Obama

Today, the Department of Labor released their monthly report on employment, and it was ugly.  The headline news is that only 54,000 jobs were created and unemployment rate increased to 9.1%.  Of course, one can argue that the rise in the unemployment rate reflects nothing more than an increase of 272,000 in the number of people looking for work.  Normally, that is a good sign, when people decide to start looking again.  This time, it just may be a sign of desperation . . .

A little deeper look shows the private sector gained 83,000 jobs, while governments laid off 29,000.  Last month, the private sector gained 251,000 jobs.  This is a huge decrease in job creation, reflecting the stalled economy, as discussed frequently in this blog.

Worse, we found out the March and April reports over-stated actual job creation by 39,000 jobs.

Maybe worst, the number of people unemployed over six months increased from 5.8 million to 6.1 million.  This is the hardest demographic to help and a real human tragedy.

The Dow futures dropped 100 points on this report.  I suspect the President's job approval dropped at the same time.  No incumbent president has ever been re-elected when the rate of employment was over 7.2%.  The President only has 17 months to change this, which will probably not be enough time.  Given that this recession was not a garden-variety recession, where employment rebounds relatively quickly, my prediction is that the Republicans can win with any serious candidate.

Wednesday, June 1, 2011

Cue Up QE3....

Yesterday, at a meeting of fellow financial advisers, I was asked if the Fed would end the current quantitative easing program and begin a new one.  I replied they should ask me at 8:31 AM this Friday, which is immediately after the monthly "jobs report."  This is easily the most important economic report each month to the Fed, and the report this Friday would be the last one before the Fed makes a decision.  If job creation falters, the Fed will have to institute some additional effort, and will be called QE3.
Today, the economic data was so bad that it is clear the economy has stalled.  The forecast for job creation this Friday immediately dropped from 190,000 to only 120,000.  Since one of the Fed's two mandates is full employment, they cannot ignore this.   It is clear to me that the Fed will have to do something.  It may not be quantitative easing, which is nothing more than the Fed buying the bonds from Treasury to keep interest rates down.  Without that, interest rates would rise, and every Keynesian economist knows the Phillip's Curve,  which shows graphically that higher interest rates produce higher unemployment.

QE2 expires at the end of June, but the Fed may extend it.  Or, they may do nothing until later in July.  Or, they may do something entirely different.  But, the Fed is not leaving the field.  With a useless Congress, they are the only defense the economy has.

With ugly economic news, it was not surprising the stock market was also ugly today.  The Dow lost 280 points, the worst day this year.  Of course, it didn't help that Moody's simultaneously downgraded Greek bonds from junk to miserable junk, which made things worse.  Part of the drop today was factoring in a default of those bonds, which means the market shouldn't react as badly when the default actually occurs.  This was a direct insult to all the European leaders who have assured us there would be no default.

One analyst asked how long the Fed can keep "the pedal to the metal?"  I'm confident Bernanke, an expert on the Great Depression, would say "as long as it takes, even if it means QE4, QE5 . . ."