ECONOMICS 101: FEWER JOBS + HIGHER DEBT 
+ LOWER RETAIL SALES = TROUBLE
by Anthony M. Cherniawski
The Practical Investor, LLC
May 11, 2007

Last week I reported that, due to the Department of Labor’s (mis)reporting, there are as many as 697,000 jobs that dropped off the payroll records in April. Now, here’s a follow-up that tells us an even more revealing picture of the state of our economy. On Monday, the Federal Reserve released the March figures for consumer credit. It is not a pretty picture. While nonrevolving credit (automobiles, boats, student loans, etc.) increased by 5.2%, revolving credit (credit cards) increased by a whopping 9.2% in the month of March. The Federal Reserve reports this as a “good thing,” because until now this has supported the so-called consumer economy. But has it? Until recently, consumption has grown alongside the debt. Now, however, we have higher consumer debt and lower consumption, as reported by the April retail sales.

What can we conclude from this? I’d be interested in your opinions, but the one inescapable conclusion is that the consequences of the negative savings rate since 2006, the consumers’ willingness to take on more debt and the loss of jobs in the past year have put our economy into a death spiral of increasing debt and declining consumption. 

So, where did that increase in credit card debt go? How about house payments and groceries?

More Mortgage Companies Implode.

According to CNN Money, subprime mortgage foreclosures are up 35% this year, which closely correlate to the percentage of mortgage resets due this year. A reset can be (1) a scheduled change in the interest rate after as few as 3 years, or (2) generated by an option-interest mortgage (called exploding arms) where the debtor fails to make minimum payments on principal or interest. In the second case, house payments may double at the time of reset. 

The word “subprime mortgage” may go down in history as yet another flawed idea from the great debt bubble. In the meantime, subprime lenders are imploding. The prospect of a zero-down payment home is disappearing fast. What impact does that have on our economy? Read Paul Lamont’s “Credit Collapse – May 10^th.”

A case for the “jitters” in Japan?

Investors in the Nikkei stock market took a hit today (not shown) after the sell-off in U.S. stocks yesterday. Folks, this is a truly global market, because the Japanese investors are concerned about severa; things, “Tsuyoshi Segawa, an equity strategist at Shinko Securities, said investors appeared eager to see how Chinese markets open following the Bank of England's rate hikes and growing concern about the U.S. economic outlook.” 

"On top of the fact that investors were already cautious before another peak of earnings announcements next week, it is unavoidable for Japanese stocks to fall on U.S. stocks," he said.

“No bubble here!”

…or so the thinking goes. “Fund managers said there is a bubble in certain stocks, but the overall market conditions are still healthy.

'With the Shanghai Composite index at 4,000 points, there is definitely a bubble in some stocks but not all of them. I personally think that most stocks are still properly valued given their extraordinary growth potential after the share reforms,' Dong Lianghong, a portfolio manager at Boshi Fund Management, said.”

A rally of over 100% in six months is not a bubble? What are these guys smoking?

Is this the end? Or just another correction?

NEW YORK (MarketWatch) -- U.S. stocks rallied on Friday, with the Dow Jones Industrial Average gaining 100 points, after upbeat news on wholesale inflation and weak retail sales boosted hopes that the Federal Reserve will eventually cut interest rates to boost a slowing economy.

The Producer Price Index for March was released this morning. Producer prices including food and energy, went up .7% in March, after a 1.3% increase in February and a 1% increase in January. Excluding food and energy, the Department of Labor reported “no change” last month. That is the so-called reason for the rally this morning? 

The Fed will cut rates…not!

UK interest rates hit their highest level in more than six years on Thursday after the Bank of England raised the cost of borrowing to 5.5 per cent. The 25 basis point increase, which had been expected by most economists, means Britain has now overtaken the US to shoulder the steepest borrowing costs of the G7 group of industrialised countries.

What we are seeing is a global environment in which nearly all central banks are trying to sop up “excess liquidity”, translation, debt. The reality is that there is a growing concern about the effects of excess debt and its inflationary effects on their economies. 

Bad news accumulating for housing.

Realty Trac reports, “The leading online marketplace for foreclosure properties, today released first-quarter data from its 2007 U.S. Foreclosure Market Report, showing more than 430,000 foreclosure filings — default notices, auction sale notices and bank repossessions — reported nationwide during the first three months of the year, up 27 percent from the previous quarter and up 35 percent from the first quarter of 2006. The nation’s quarterly foreclosure rate of one foreclosure filing for every 264 households was the highest quarterly foreclosure rate since RealtyTrac began issuing its report 27 months ago.”

The reports of my death…

…are greatly exaggerated. (Attributed to Mark Twain) The long-awaited death of the U.S. Dollar seems a bit premature. The slowdown in the U.S. economy has the potential of making dollars scarcer, and therefore, more valuable. 

Nouriel Roubini has some recent comments in his blog that suggest our economy is growing at a far slower pace than reported. A further slowdown in consumer spending may bring dollars into much stronger demand. 

The last dip was no buying opportunity. 

From MarketWatch, May 9, 2007, “The Fed made no changes to its inflation outlook, saying that core inflation remains "somewhat elevated" and "although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures." 

"With the Fed telling the market they are keeping a close eye on inflation caused by huge amount of liquidity in the system places them in a difficult position," said Peter Spina, analyst at GoldSeek.com. "A weakening economy and inflationary problems leave them with two options: sacrifice the dollar or the economy," Spina said. "The market appears to agree that the US dollar will be a victim of the situation, which will result in taking gold to much higher levels." 

Ahem! Is there a nay in the crowd?

 Gasoline inventories have stopped declining…for now.

The Energy Information Agency suggests that $3.00 gasoline is here to stay…for awhile. But for the moment, gasoline inventories have stopped declining, which should ease the pricing pressures for now. 

But in just two months, hurricane season will be upon us. This year’s forecast is for a more active hurricane season, with at least one major storm in the Gulf.

Spring in the Mid-west, but Summer weather in the South…

Also from the Energy Information Agency Natural Gas Weekly Update, “After a dip in the temperatures during the first half of the report week in the Northeast, the return of spring-like temperatures led to an easing in the spot market prices in this region, recording average decreases of 20.0 cents per MMBtu on the week, to a regional average $7.97 per MMBtu yesterday. The formation of the first tropical storm of the season had no effect on the natural gas prices other than dampening the cooling load in the South Atlantic States of Georgia and Florida.”

Is the credit binge in investments due for a bust?

“We have a long-held thesis that says our economy and our markets have been the beneficiary of a credit binge. The Economist has come out and said the four-year growth rate in the global money supply has been 18% a year compounded. You see it anecdotally in terms of the amount of debt in the system. We're academic believers of the Austrian school of economics. We understand if you create credit greater than nominal GDP, it can result in inflation. But a lot of people just think of inflation as goods-and-services prices. Instead of in goods-and-services prices, you can have inflation in asset prices. To some people that's wealth creation. But if it's due to credit growth, it can be very dangerous. It can be unstable, and it can create seeds of our own destruction.” 

SmartMoney.com’s interview with David Tice of the Prudent Bear Funds gives us some insight in why investing in this market can be very dangerous. Not only is the consumer economy breaking down because of excessive debt, we also have an “investment economy” dependent on excessive debt. While the consumer economy unravels in slow motion, the investment economy will not afford us that luxury. 

Regards,

Anthony M. Cherniawski, 
President and CIO

Disclaimer: It is not possible to invest directly into any index. 

© 2007 Anthony Cherniawski
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Anthony M. Cherniawski
President and CIO
The Practical Investor, LLC,
State Registered Investment Advisor
East Lansing, MI USA
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