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Fed Chairman Greenspan has repeated the accommodative policy which succeeded in every past business cycle, to provoke the recovery with low interest rates. But wait, monetary excess caused the stock bust and its associated recession in the first place!!! Monetary ease cannot cure a problem that it caused!!! Why bother to change a tried & true method from the established playbook? Because they know nothing else. Examine the outcome to date. After three years, the US Economy has seen only two quarters with annualized 4% GDP growth. Job growth is abysmal. In 27 months, the economic recovery has produced a shortfall of nearly 8.2 million jobs, when compared to past hiring trajectories. Few seem to question why the outcome is so weak, against a backdrop of such a sharp rise in the monetary aggregate.
An unusual debasement of the USDollar has been in progress for over three years. The first step in 2001 saw the re-emergence of the yield carry trade via massive bond speculation. Money is borrowed at a low short-term rate, and invested in long-dated Treasurys. This racket is highly profitable, but only available to the highest quality borrowers. Each round of Fed cuts ushered a new round of carry trade speculation. Hundreds of billions of USDollars are generated and spewed into our economy annually from this highly effective, but debilitative, monster apparatus. Financial engineering is the enabler of both inflation and deflation, even as it gradually destroys the real economy The second step of the dollar debasement occurred with the growth of the real estate bubble, powered by the mortgage finance movement. After ample goading, Greenspan convinced bond speculators to push down mortgage rates later in the year 2001. The refinance deals are seen as rescue devices for the economy as a whole, when in reality we burn our furniture (home equity) to maintain a certain standard of living. Little heed seems paid to the parallels to Japan in the 1980 timeframe. Their bank system linked loan portfolios to both the inflated stock price and real estate price structures. Systemic failure of their entire banking system followed, which stalled economic behavior for over a decade. Is the United States ratcheting its mortgage finance system (banks and GSE agencies) in parallel fashion? Methinks YES. We march into the trap with history at our side, revised to be sure, and blinders on our eyes. As a nation, we greedily seek out new bubbles to exploit, despite the near guarantee of their temporary nature. The third step of the dollar debasement process has been managed by a Fed proxy, the Japanese central bank. Since 2003, the Bank of Japan has done the Fed’s bidding under the implicit directive to preserve an export business. The Greenspan Fed must feel little urgency to monetize the Treasury debt when the BOJ will perform the task while we sleep. They squandered $184 billion in the last calendar year, and have already scattered another $100 billion in January and February of 2004. March granted them holiday, as the Japanese enjoy the annual Repatriation of funds from foreign lands, and IRS tax payments are anticipated to flow in earnest into Washington DC coffers. In a sense, foreign central banks are held hostage, coerced into supporting the USDollar. The initial co-conspirator is the nation with the greatest export dependence, Japan. The next unwilling participant might well be Germany, whose export business has largely vanished in the last year from strong euro currency appreciation. The European Roundtable takes its lead from its First Knight, Germany, which commands the largest industrial power base in the Eurozone. Printed paper is the coin of the realm. The Fed’s printing press is the quintessential machine within the American financial engineering laboratory. The Fed has paradoxically placed our aggregated economy in greater jeopardy of price deflation from several powerful factors. The outcome is not just sour fruit, but a monumental backfire from failed policy. Amidst exaggerated progress lies a monumental leakage in the arthritis-ridden body economic, which has developed fresh new arteries in the hemorrhage of precious capital blood loss to Asians. Follow the Money Any competent economist must heed the famous words of the Watergate Deep Throat (my guess is Alexander Haig), if sound analysis dictates analysis of inflation implications. Most American economists command questionable analytical competence, suffer from blatant vested interest, operate in an irrelevant academic ivory tower, or act more like political apologists to promote an agenda. Institutional economists have fast become a political priesthood, which has sold out solid defensible analysis methodology in favor of adaptive malleable political ideology. My personal disdain for economists is well established. The raison d’être for my website and its chronicled in-depth analysis is to kick sand in the faces of the financial establishment, whom I label the “unenlightened cognoscenti.” For a comprehensive indictment of this compromised and inept profession, see “A Statistician’s Indictment of Economists” (August 2003) wherein 12 counts are litigated for incompetence, deception, and collusion. Friends of the court are cited, such as Stephen Roach, Bill Gross, David Tice, and Paul Kasriel. From the brokerage world, Bernstein, Dudley, and Sullivan offer solid analysis. One should attach significance to the failure of any economist to receive an Economics Nobel Prize in almost 20 years. A statistical analyst enjoys a huge advantage over mainstream economists, whose indoctrination demands acceptance of a host of fallacious foundations and assumptions, beginning with acceptance of a debt-based currency and a debt-dependent economy. Most economists must bend to political forces, either in government or corporations. Where goes the new money? Knee-jerk analysis lacks competent thought. We often hear about the business cycle “due to kick in,” which is utter nonsense. The current business cycle bears no resemblance to that of the 1960 decade, and little similarity to the 1980 decade (China was not a player). It has been severely altered by globalization, by debt burdens, by foreign dependence, and by technology itself. The high valuation of the USDollar has resulted in systemic lack of competitiveness. This is not your father’s business cycle anymore. For a more thorough discussion, see “The Broken Cycle: Paradigm Shift” (January 2004) wherein forces of globalization, changes from service sector outsourcing, and absent pent-up demand are covered in more depth. One cannot sit back on a recliner, read the newspaper, and expect passage of time to bring about traction of current monetary policy. The US Economy is a fast evolving system. It has been long stated that true wealth comes from “building it, growing it, or mining it.” American economists encourage “printing it” arrogantly, with little respect shown to the history of inflation or its effect on the US and world economies. We attempt to cheat Mother Nature, and invite her wrath in response. It is soon in coming, and might be in our midst now. New money goes into several avenues, few of which foster sustainable growth, and most of which attempt to continue the futility of the past spending patterns in the maintenance of horrendous imbalances. If we are to follow the money, sign posts make the task easy. Merely follow the “triple zero” deals. Zero deal promotions are a symptomatic signpost of the last hurrah in a death march toward the Liquidity Trap. The most obvious are:
The used car market has been decimated. One third of all automobile loans are reported as underwater, whereby the loan balance exceeds the depreciated car value. Some argue that residential housing comes close to offering zero percent, zero deposit, but not zero payments for a period of time. Lending requirements are certainly as liberal now as in any recent period. Extraordinary Asian vendor financing and largesse on an intercontinental scale do make for ample supply of credit. With repeal of the business cycle’s principal tool (recession), economic soil is unprepared for a viable recovery. We have interrupted and altered the business cycle radically. Recession is not permitted; it is deemed politically unacceptable; it is actively circumvented. Consumption is perpetuated, even if it approaches the absurd. The result is continuation of debt overload and removal of the pent-up demand spring board, essential to a nascent recovery. Recovery is heralded prematurely. Much new money goes toward evermore debt in the listed items, as often in an orgy of excess as in the meeting of needs. While income growth from wages has almost collapsed since the year 2000, consumer spending has risen 10% on an inflation adjusted basis. Total consumer debt, from both revolving and installment sources, has risen over 17% since January of 2001, from $1711 billion to $2019 billion. During the same stretch of time, the Chinese trade deficit accumulated by a commensurate $322 billion. Hmmm, roughly the same magnitude.
Debt levels have risen dramatically, and without much alarm signaled by our hapless corps of compromised economists. Since the mid-1990 decade, personal consumption as a share of GDP has grown from 63% to 70%, while savings have not only disappeared, but probably turned negative. Whatever the cause, we spend more, save less, and extend credit. In the 1960 decade, debt service on a national level hovered under 30% of GDP. Now it approaches the 80% ratio of GDP, a stiff headwind. How can such a high figure have been permitted to come about? Just ask that question to a new car buyer offered a 0% deal with no down payment. Ask the person who is given an unsolicited 0% extension for six months on yet another card. Ask the homeowner who refinances or extracts home equity for bills. We as a nation rack up debts with more ingenuity and speed than any culture on earth. Our leaders amazingly believe persistent consumption, even if financed by credit, can lead us to recovery. This thinking is backwards, and invites a deep recession down the road. Few realize, as Kurt Richebächer urges, that extreme imbalances are powerful enough to cause recession. Leakage of Capital & Jobs Consumer debt has risen dramatically since the year 2000. Chinese and other Asian nation trade surpluses have risen at the same time. The transfer of capital is enabled by eager borrowers and accommodative interest rates, pressed onward by profligate spending and absent domestic industrial output. One could argue that the Federal Reserve reflation initiative indirectly promotes Asian growth. The spearhead for that growth is obviously China, which appears to pull the struggling Japanese economy forward. Over the last three years, the trendline for Chinese trade deficit growth runs at a rate of $159 million increase per month. The annual trade gap with China tracks at roughly $130 billion.
New investment is going abroad, where profitable outlook seems brighter. Direct foreign investment in China runs at an astounding level, half of which originates from American firms. Much fanfare has been exhibited regarding the capital investment revival in US computer and network systems. While telecom’s glut and bust in 2000 has been in the process of being worked off, computer systems have led in the recent capex lift. However, any move to rejoice is premature. Infotech systems are a critical piece in the outsourcing of jobs to China and India, displacing American workers. Nowhere is the harness of technology more vital than in the shipment of knowledge and information output. The internet and networks have revolutionized global commerce dynamics. Investment by US firms grows fast, as seen with IBM, General Electric, Oracle, Intel, EDS, Computer Sciences, and Accenture. Connectivity at broadband speeds has created a critical umbilical cord to Asia, where our firms exploit uniformly cheaper labor. We as a nation are at an absolute disadvantage; there is no comparative advantage. Such is global commerce today. Sadly, the import of productivity explains well domestic expansion without wage growth. Put aside the recent April report which claimed 308,000 jobs created, since close examination reveals a glaring bent toward temporary and part-time jobs offset by a decline in average wages. A full 100 thousand of those new jobs come from seasonal adjustment. The average weekly paycheck in March for the private sector was $523.70, down a surprising 88 cents from the average February $524.58 paycheck. New Money Adds to Deflationary Pressures Unfortunately, most new money creation adds to already high debt burdens. Steadily growing demand for materials and energy combines with historically neglected and obstructed supply chains to add pressure by an order of magnitude on production costs. New speculation in commodities is evident such as in crude oil, silver, copper, soybeans, and other contracts. This translates directed into downward pressure on profits. Wages are in chronic decline, directly from induced rising costs, and indirectly from available Asian outsourcing. The Fed’s reflation initiative has failed to achieve higher wages. Worse still, new money has added to the debt burden and overhang to such an extent that bankruptcies are hitting record levels (1.6 million last year). Foreclosures are also hitting record levels, when a real estate boom is proclaimed, and record low mortgage rates are advertised. Something is obviously awry. A monumental middle class squeeze is underway. Most so-called experts cannot properly define inflation. Is it the effect or the initial action? How can a problem be properly treated if it cannot be defined or diagnosed, let alone its root causes identified? One can tragically defend the position that recent Federal Reserve expansion of the money supply has initially led to far greater deflationary pressures within the economy. Not only are production costs and shipping costs rising, but household budgets are more strained. Corporate profit margins are being squeezed, and household discretionary spending is being hindered. Two decades of exported monetary inflation has built the Asian region’s manufacturing capacity to such an extent that pricing power is nonexistent in our domestic economy. Pricing power will return when China enforces it. The result has guided a renewal of offshore production and an acceleration of job outsourcing, thus massive job layoffs and reduced wages in the aggregate. Fed-forced easy monetary policy has led to lower saving interest income (Treasurys, bonds, CD’s), whose volume is twice that of interest payments (mortgage, installment, credit card). On a net basis, less income is generated within the US Economy. Those sacrificed are retirees and the vital insurance industry, a conservative mainstay. Wall Street never brings attention to the deflationary impact of lower interest rates to the real economy. Instead, it focuses upon the incentive for renewed speculation and higher stock valuations linked to the absurd Fed Model. Such a valuation model is obsolete in a secular deflationary trend. Those who doubt its irrelevance should examine the Japanese Nikkei collapse late in the 1980 decade, that is, unless they are employed by a prominent brokerage or investment banking firm. Federal Reserve Reflation policy has backfired and failed. It has resulted in even greater deflationary pressures ahead. In the corporate and household arenas, the only evidence of price inflation lies within cost structures, not income sources. Large contracts which span many months are causing havoc, losing money, since endangered by non-negotiable cost increases. The threat of bankruptcy, loan default, and further cost cutting (i.e. liquidation) has never been greater. As credit deteriorates, capital is burned, and the money supply is reduced. Wages are in caught in a devastating downtrend. Job insecurity should remain an everpresent boogeyman for our nation of besieged workers. News Tidbits DuPont announced 3500 job cuts (6% of its workforce) to take effect before December, in response to higher material costs. Microsoft settles yet another anti-trust lawsuit, this one with InterTrust for $440 million, over digital media rights. WalMart reports weekend retail sales above expectations, with strong apparel & decoration transactions. Comcast is rumored to be set to walk away from the Disney deal, and withdraw its tendered offer. Taser sparks toward $100 per share. Intel reports earnings tomorrow, much anticipated. A busy week lies ahead, as higher commodity prices assist resource companies, but hurt mainstream firms. Multi-nationals continue to benefit from the declining dollar effect. The much-watched put/call ratio sits at a high 2.5-to-1, above its 1.5 norm, which typically contra-indicates higher equity prices. Bluechip economists now forecast a 4.6% GDP growth rate, down from 4.7%, while 67% expect a Fed rate hike this year. They foresee a crude oil consensus price of $31.20 per barrel by year end and a modest rise in S&P earnings. The movie “Alamo” was a disappointment, coming in third place behind “Passion” and “HellBoy” with only $9.2 million at the box office. Portrayal of Davey Crockett as a country bumpkin did not go over well. No longer a bridesmaid, lefty Phil Mickelson won the Masters golf tournament in dramatic fashion. The Ephedra drug ban goes into effect today, following 16 thousand FDA complaints, 164 deaths, four since the agency’s intent to ban. Its 12 million customers must now find alternatives. Iraq approval ratings have slipped from 59% in January to 48% now. Iraq success perception has slipped from 43% in January to 26% now. Today's Market The Dow Jones Industrials closed at 10,515 (+73.5), S&P closed at 1145 (+5.9), Nasdaq at 2065 (+12.6). TENS yield rose to 4.23%, where it rests just below a perceived pivot point. Euro closed at 120.5 (unch), Japanese yen at 95.05 (+0.81), Canadian Dollar at 74.58 (-0.58). Gold finished at 420.1 (+0.6), silver at 8.03 (+0.02), copper at 1.30 (-0.01), crude oil at 37.84 (+0.71), natural gas at 6.01 (+0.06) showing a strong move in the last month, unleaded gasoline at 1.18 (+0.03) to make new highs. Commodities are priced at nearby futures contracts. Noteworthy is the REIT index. The RMS fell 5.1% today, signaling a threat either to mortgage rates or to income. Leading groups were telecom, biotech, broadcasting & cable TV, forest product, oil services, and chemicals groups. Laggard groups included the utility, real estate operations, and homebuilding sectors. The pullbacks in the homebuilding and real estate operations groups accompanied a decline in the bond market, where the 10-year note was down 10/32, bringing its yield up to 4.23%. Jim Willie CB
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Since
January of 2001, when the Federal Reserve embarked on a path extending
over 20 months to reduce Fed Funds targeted interest rates down to 1.0%,
the resolution is incomplete, uncertain, and hardly successful. By many
measures, the outcome is arguably a failure. Aggressive monetary
stimulus has jolted the economy and financial markets, to be sure.
Clearly absent has been a foundation upon which to build an economic
recovery. Twenty years of a rising USDollar, energy reserve depletion,
and offshore manufacturing has led to an “evolution of dependence”
which leaves our nation highly vulnerable in its supply of energy, raw
materials, and capital. Also absent have been the internal dynamics to
force traction of monetary policy into actual commercial performance.
The foundation lacks the pent-up demand, principally in the car and
housing sectors. More critically, it lacks domestic savings from which
to recapitalize. The internal dynamics have been indeed radically
altered by the rapid evolution of globalization itself. The business
cycle has changed to the extent that cyclical behavior is challenged and
debated. The cycle may be broken.
