Monday, January 16, 2012

The EU Has Fallen Into a Liquidity Trap and It Can't Get Up



The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While the EU is still reeling from S&P's downgrade of the sovereign debt of nine of its members on January 13th and the latest talks to keep Greece afloat have hit a wall, there is an even bigger problem with the effectiveness of its stimulus programs -- the money is just not finding its way into the economy.

Global markets were jubilant in December when the ECB (European Central Bank) pumped 490 billion euros of three-year loans into the EU banking system. These funds were used by eurozone banks to buy high-risk government debt from the struggling peripheral countries. This indeed caused a temporary decline in interest rates, especially for Spain and Italy. Money from this program and other EU stimulus measures is stuck in the banking system however and it is doing little to keep the EU from sinking into a deep recession. As of Monday January 16th, the ECB had 493 billion euros on overnight deposit -- more than the entire December stimulus package.

Large amounts of funds on deposit at any central bank are an indication of a crisis in the banking system. Before the current EU debt crisis, eurozone banks usually kept only around 100 million euros on deposit at the ECB. Even during the height of the 2008 Credit Crisis, EU banks kept only around 33% of money lent out by the ECB on deposit. The percent now is over 70% (the ECB has lent out 664 billion euros in total) meaning things are in much worse shape in the EU than they were after Lehman Brothers collapsed. When money is trapped in the banking system, the economy suffers and extra stimulus measures don't help to revive it. EU money-printing measures meant to rescue its profligate debt-ridden members aren't likely to help its economy, which in turn will result in a self-feeding cycle of more and more debt (as happened in Japan during the last two decades) or more and more money printing (as has been taking place in the U.S. since the 2008 Credit Crisis). Like the U.S., the EU has run out of borrowing power, so debt without money printing is no longer an option.

Weaker economies mean more downgrades from the ratings agencies can be expected. On Friday, both France and Austria lost their coveted triple A ratings from S&P. They were downgraded a notch as was Malta, Slovakia and Slovenia. Italy, Spain, Portugal and Cyprus were downgraded two notches. Italy is now rated BBB+. The only countries in the eurozone that still have triple A ratings are Germany, the Netherlands, Luxembourg, and Finland. S&P put the later three on negative outlook for a possible future downgrade however. The EFSF bailout fund itself may also be downgraded.

The current debt crisis that is now impacting the entire eurozone started in Greece in late 2009. The problems there have yet to be fixed despite numerous mainstream media reports to the contrary in the last two years. Greece is now on financial life support. Any missed bailout payment from the EU will send it immediately into default. Talks have broken down once again, but as before will once again be resuming shortly. The market has never been convinced that any of the proposed Greek bailouts will work.  On Monday, Greek one-year government bond yields hit a high of 416% and 10-year yields a high of 35%. These rates have continued to rise after each bailout proposal. Greece has to make substantial bond payments this March.

The EU's debt crisis is not getting resolved because it is no more possible to solve a debt crisis with more debt than it is to sober up a drunk by giving him more alcohol. Yet, every mainstream news article has comments from well-placed sources that are hopeful that some resolution will be coming to the EU's problems soon. Rarely is it mentioned they have been hopeful -- and wrong -- for the last two years as the situation has increasingly deteriorated. Nor is it mentioned that the Japanese with similar problems in their financial system have now been hopeful for twenty years that their economy will fix itself. Wishful thinking doesn't fix markets, nor do plans involving spining straw into gold -- no matter what central bankers and their toadies claim.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Thursday, January 12, 2012

Retail Sales and Employment Not as Good as First Reported

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

There has much cheerleading in the mainstream press lately about the improving employment situation and strong 2011 holiday retail sales. Just released figures indicate it may have been much ado about nothing.

Retailers depend on the holiday season for their yearly profits. Major efforts were made in November to get people to start buying early. This worked and retail sales were up 0.4% during the month. Strong early numbers don't necessarily mean overall numbers will be greater however. It can simply mean that buying activity was frontloaded and the later numbers will then be weak. This is exactly what happened. Retail sales were up a whopping 0.1% in December (retail sales are not adjusted for inflation, the number would be negative if it had been).

Looking inside the report shows how incredibly weak the consumer is. Excluding autos, which are highly volatile, retail sales were 0.2% lower -- the first drop since May 2010. Core retail sales, which exclude autos, gasoline and building materials were down 0.1%. Even though it was the height of the holiday buying season, spending at electronic and appliance stores was down 3.9% and spending at department stores was down 0.2%. Once again, if the numbers had been adjusted for inflation they would have been even worse.

So how come U.S. consumers aren't spending more now that the employment situation is supposedly getting better?  Well, maybe it's because it isn't. The big news lately has been the declining weekly claims which have fallen below the traditional 400,000 per week that indicates recession. However, for the first week of 2012 they came in at 399,000 -- back at recession levels. This was up from the 372,000 reported the previous week (three states including mega-sized California didn't send in their claims numbers for this report).  Of course, the mainstream press blew the trumpets about the "good", but highly questionable, 372,000 number, just as it did for the 200,000 jobs that were allegedly created in December 2011.

Among these jobs were 42,000 new messenger positions. While it's more likely that 42,000 messengers were hired in December than 42,000 nuclear physicists, that doesn't mean it is believable. Messengers work in a field with declining employment. The December jobs report has been criticized as having "statistical adjustment" problems. Non-statisticians generally refer to this as lying about the numbers. Of course, the appearance of suddenly improving economic news (not to be confused with an economy that is actually improving) at the beginning of a presidential election year should not be surprising.

As the election season heats up, there will be a desire for the government to report that economic conditions are better than they actually are.  This does not mean the news will necessarily be good, it will just be better than it actually is. Expect the bad news to come out after the November election.  Until then, invest with caution. 

Disclosure: None


Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Friday, January 6, 2012

U.S. Non-farmPayrolls -- The Statistical Illusion of Jobs



The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The Employment Report for December 2011 was released today with a glowing press release from the BLS (Bureau of Labor Statistics).  The highlight of the report was the 42,000 courier and messengers jobs created last month and the claim that the unemployment rate fell to 8.5%

Statistics can easily be manipulated and it is not unknown for political regimes to do so in order to hold on to power (and 2012 is an election year in the U.S.). After all, it is much easier to change a number than to fix the underlying problem the number represents. Fortunately, the BLS publishes a number of statistical Tables with each monthly report that can be used to check its calculations.

When the Great Recession began in December 2007, the civilian non-institutional population of the United States was 189,993,000. At that time, the number of people in the U.S. labor force was 125,588,000. As of December 2011, the BLS states that the employment population ratio for the U.S. is 58.5% (0.585). The non-institutional population of the U.S. was reported at 193,682,000 or 3,689,000 higher than it was in December 2007. The labor force in December 2007 was 125,334,000 and multiplying the increase in the U.S. population in the intervening four years by the employment population ratio indicates that the labor force should have increased by 2,158,000 to 127,492,000.  However, the BLS reports the U.S. labor force last month was 124,114,000. More than three million people are missing from its figures.

The smaller the labor force is, the better the headline unemployment rate becomes. The BLS claims these three million plus people left the labor force and this justifies purging them from the statistics. There is a problem with their line of reasoning however. Large numbers of people only leave a labor force during periods of severe economic distress.  It does not happen during economic recovery. It does not indicate an employment situation that is improving.  Yet, the BLS produces numbers showing things are getting better when this happens. This violates the first rule of statistics -- the results must reflect reality. The BLS numbers do not.

Dividing the number of employed in December 2011 by the size of the labor force that should exist based on the population numbers produces an unemployment rate of 9.6%, not 8.5%. This is the headline number that should be reported. If the BLS wants to insist however that more than three million people have indeed left the labor force (and this has continued in the last year -- the size of the labor force in December 2011 is smaller than it was in December 2010), it should also make it clear that this indicates that there has been an ongoing recession and no economic recovery has taken place. Both can't happen at the same time, except for a brief period. Either the economic recovery story is a lie or there hasn't been a shrinking labor force. 

While mainstream economists will insist that employment is a lagging indicator (more than two years is some lag), this has only been the case in the U.S. years after statistical "improvements" were introduced in the 1980s and 1990s in how government economic numbers were determined. Before that, employment recovered with improving GDP as should be the case. If you think about it, the term jobless recovery makes as much sense as tall midget or genius moron.

The improvement in the weekly unemployment claims is also being cited as evidence of an improving jobs picture. It would be more accurate to say that it is evidence of a jobs picture than can't continue to get worse. As I have stated since at least mid-2010, the weekly claims number will regress toward the mean (move to its long-term average) because eventually there will be few workers who remain to be laid off. After being elevated for several years, the only way that weekly claims  can now increase is with a big jump in bankruptcies. This will be avoided as long as the economy holds steady.

What is keeping the U.S. economy from getting worse is the unprecedented budget deficits that the U.S. is running. If you spend an extra $1.3 trillion dollars that you don't have as the U.S. did in 2011, this will certainly stimulate the economy in the short-term since much of this money winds up in consumer pockets and they spend it.  According to the non-farm payrolls report for December, the U.S. is not exactly getting good value for this money. Unless of course, you think low-paying courier and messenger jobs should be the cornerstone of the economy.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
 Organizer, New York Investing meetup
 http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Wednesday, January 4, 2012

How Today's "Deflation" Can Turn Into Tomorrow's Hyperinflation

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Since the 2008 Credit Crisis, deflation has been the primary worry of mainstream economists and monetary and fiscal policies that utilize various forms of “money printing” have been implemented throughout the world to try to stop it. Unfortunately, money printing combined with deflation can potentially lead to hyperinflation.

Hyperinflation is a little understood and little studied phenomenon. Even inflation itself is only partially understood and traditional university economic programs devote minimal attention to it (just ask someone with an economics degree what courses they took in inflation). Almost no one seems to have made the connection between deflation and hyperinflation, which are intimately related. Hyperinflation in fact could actually be defined as a self-feeding cycle of severe deflation combined with escalating money printing.

Historical analysis shows that hyperinflation is a creature of damaged and dysfunctional economies. It does not come from overheated economies that continue to grow out of control resulting in ever higher inflation rates.  This mythical view may have been created because government stimulus measures the employ money printing in its various guises to deal with   deflation can briefly make the economy fervent because of a declining currency. This creates high export demand since foreigners can buy the country’s goods cheaply and high internal demand because the population becomes desperate to get rid of any currency it holds. This phase does not last however and it takes place just prior to the final hyperinflationary spike. It was seen in Weimar Germany in 1922 because Germany had a developed manufacturing economy and most of the rest of the world wasn’t experiencing currency devaluation.

In many cases in the past, war preceded hyperinflation. This happened in Germany and Eastern Europe after World War I and in Eastern Europe and Japan and East Asia after World War II.  It also occurred in the United States after the Revolutionary War (arguably the first case of hyperinflation in history) and in the South at the end of the Civil War. Demand can collapse after a war and this will cause prices to drop (the U.S. had sharp deflation after World War I for instance). Governments, who were already printing money to support the war effort, then frequently print more to stimulate the economy.  If the economy isn’t brought back to real functionality however, a country’s currency loses its value and an ever-increasing amount of money has to be printed to create the same amount of stimulus.  

Even if there is no war, hyperinflation can exist just because an economy is dysfunctional. This would describe the cases of hyperinflation in South America, post-colonial Africa, and in Eastern Europe during the collapse of communism.  When an economy just can’t create enough demand on its own, the authorities stimulate demand by printing money. This leads to the same cycle of currency devaluation and ever-increasing money printing in an attempt to keep up with the loss of value taking place. In reality, the economy is continually shrinking, even though prices start heading toward the heavens.

While this has happened in a number of countries over time, mainstream economists continually make the claim that inflation can’t exist if there is slack in the economy. Hyperinflationary economies actually have maximum slack, with Zimbabwe in the 2000s being the extreme example. Unemployment reached 94% there, while the inflation rate was climbing to the sextillion percent level (a number so huge it might as well be infinity). Despite this real world example that took place right before their eyes, a number of economists had no trouble looking right into the TV camera and telling the public that inflation can’t exist if there is excess capacity in the economy. If they had been testifying in court, they would have been arrested for perjury.

Since hyperinflation has only occurred in certain countries at certain times, it is important to ask what it the key factor or factors that lead to it. The short answer would be: deflation created by demand destruction, followed by money printing that is taking place because the ability to borrow doesn’t exist or has been exhausted. Since developed countries have better credit and can borrow more, hyperinflation is less likely to occur in them than in more marginal economies – at least until their lending sources dry up.   

Deflation in and of itself does not lead to hyperinflation. It depends on what the root cause of the deflation is. There were deflations in the late 1800s and in the 1920s in the U.S. due to technological innovations and not demand destruction as commonly takes place after wars. Lack of demand was not the cause of falling prices, rising supply was. The exact opposite situation takes place after a destructive war or in an economy in a post-bubble era (as is the case currently in the U.S., the UK, Europe and Japan).  In the latter case, demand needs to be stimulated, in the former it doesn’t.

Countries also don’t print money if they can borrow it. Less developed countries have limited and sometimes no borrowing ability and this means they turn to money printing early on and this makes them more prone to hyperinflation.  Since developed countries can borrow money, they do so for as long they possibly can. This has allowed Japan to get its debt to GDP ratio to an astounding 229%. The U.S. is already over 100% (based on official numbers, the ratio using more realistic numbers is much worse) and rising rapidly.  Despite its twenty years of economic malaise, Japan has managed to support demand by running huge and continuing budget deficits funded by the massive savings of its people (money printing has been relatively minor).  It is not likely any other developed country will be able to accomplish what Japan has done.  Japan also seems to have reached the end of the borrowing road and will have to start revving up the printing presses in the near future.

In contrast to the Japanese, Americans save little and haven’t been able to fund their budget deficits internally for decades —the U.S. relies on foreign sources for this money. When the Credit Crisis arose, foreign lending became inadequate and money printing began in earnest. The Federal Reserve increasing its balance sheet by over $2 trillion is only one example of this. While foreign lending might have continued to fund $400 billion dollar annual budget deficits, it was not adequate to support the $1.42 trillion, $1.29 trillion and$1.30 trillion deficits that occurred in 2009, 2010, and 2011. Trillion dollar deficits are going to with the U.S. for many years into the future and the only way they can be completely funded is by printing more and more money.  The EU isn’t in much better shape either and has been unable to fund its peripheral country debt by borrowing. Its current solution is to print money through massive credit expansion.

Claims that money printing won’t be harmful in the 2010s because inflationary policies were utilized during the 1930s Great Depression and they worked well back then are moreover completely misleading. The debt level of the U.S. government, businesses and consumers were minimal at that time compared to what exists today. Huge amounts of untapped borrowing capacity existed then, but this is no longer true. Consumer credit expanded so much in the intervening years that during one month of the Credit Crisis it dropped more than the entire amount outstanding at the end of World War II. An apt analogy might be one drink of alcohol won’t be harmful. If you haven’t had anything to drink yet it isn’t likely it will be. If you have already had twenty glasses, it might cause fatal alcohol poisoning. The global financial system now risks being poisoned by money printing.
The monetary authorities worry about deflation and attempts to handle it with money printing are nothing new. The current actions are disturbingly similar to what took place in Weimar Germany in the early 1920s. They handled their deflation problem with money printing as well. As prices rose, instead of facing reality, the economics establishment acted in concert to deny the obvious. Deflation was cited as the biggest danger to the economy until it became laughable. When inflation exploded, the usual scapegoats — foreigners, speculators and minorities — were blamed by the government. Unless human behavior has changed in the last 100 years, the same scenario is likely to play itself out again in the 2010s.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Tuesday, January 3, 2012

The Risks to the Global Financial System in 2012



The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.   
As 2012 begins, markets are rallying as they did at the beginning of 2011 -- a year when the S&P 500 closed flat after many huge moves up and down. The problems in Europe that rattled markets in 2011 have not been resolved and new problems are or will be emerging in China and Japan. At the very least, investors should expect another rocky ride in the upcoming year.

The debt crisis in the EU is far from over. It is simply being momentarily contained by another short-term solution that will hold things together for a while until the crisis erupts again. The mid-December LTRO (long term purchase operations) announced by the ECB excited the markets as any money-printing scheme would. This new "solution" to the debt crisis is essentially an attempt to handle a problem of too much debt with more debt. Already close-to-insolvent EU banks are able to hold fewer assets for collateral in exchange for cheap funding from the ECB, which can in turn be used to buy questionable sovereign debt from the PIIGS. While this will keep Italy, Spain, Portugal and Ireland financially afloat for a longer period of time, it may collapse troubled EU banks sooner (the real epicenter of the debt crisis). 

Half way across the globe, problems are emerging in China. It is estimated that there are between 10 and 65 million empty housing units in the country that investors have purchased with the hope of selling at higher prices. There are in fact entire "ghost districts" there that are filled with new buildings and no residents. Prices have become so high that by last spring the typical Beijing resident would have to have worked 36 years to pay for an average-priced home. The pressure appears to be coming off though with new home prices dropping 35% in November. Beijing builders still have 22 months of unsold inventory and Shanghai builders 21 months. In the peripheral areas, existing home sales have plummeted -- down 50% year on year in Shenzhen, 57% in Tianjin, and 79% in Changsha. Investors should take note that the Chinese real estate bubble is far worse than the U.S. one that brought the global financial system to its knees at the end of 2008.

Twenty years ago, Japan had a massive real estate bubble and it is possible that prices have finally bottomed there, but that doesn't mean that they are ready to go up. Japan has had two decades of economic stagnation (and is heading toward a third, if it is lucky) because of the collapse of its real estate and stock market bubbles. Massive borrowing by the government has prevented the situation from getting worse. The debt to GDP ratio in Japan is now estimated to be 229% (well above the just over 100% in the U.S.).  More people are leaving the workforce there than entering it and this bodes ill for tax receipts. The aging population is using up its savings instead of adding to them. This is a potentially serious problem because the massive debt the Japanese government has incurred has been funded mostly internally by the savings of the Japanese people. A lot of old debt has to be rolled over in 2012 and additional debt is still being incurred. Where the money will come from is not clear.

None of the problems that could strain the global financial system originated in 2011. They have been building up for years and even decades. The first major blow up was the Credit Crisis in 2008. In every case, that problem was "solved" by more debt and money printing. This approach has of course only postponed the inevitable since taking on more debt only creates a bigger debt problem down the road and you can't create something of value out of thin air by printing money (although you will ultimately create a lot of inflation). The markets have already spent most of 2011 in an unstable state. It looks like continuing and even bigger crises await investors in 2012.
Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security