BOE Kicks Off New Global Money Printing Cycle

 

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.

Markets like money printing. The Bank of England (BOE) today announced its own QE2.  Statments from Fed Chair Ben Bernanke and talk of the EU recapitalizing its banks was already juicing up global stocks before the BOE took this earlier-than-expected action.

In its latest round of quantitative easing, the BOE will be purchasing 75 billion pounds in bonds. While some news reports euphemistically described this action as the BOE will be "spending" the money, the correct phraseology is that it will be "printing" this money. The BOE has previously printed 200 billion pounds to buy bonds starting in 2008 during the first credit crisis. The U.S. Fed has already engaged in two rounds of quantitative easing (only one of many ways that money can be printed) and a third should be expected.

Stocks had already turned around on Tuesday with big rallies. Fed chair Ben Bernanke made a statement that he was willing to do more to help the economy. Bernanke has been "helping" the economy since he started lowering the fed funds rate in September 2007. While he has helped the economy, the U.S. has experienced the worst recession and worst bear market since the Great Depression in the 1930s, the official unemployment numbers have remained close to double digits, the U.S. has had the largest number of bank failures since the Savings and Loan crisis, and thanks to his quantitative easing, the U.S. has been able to run a series of trillion dollar plus budget deficits that are going to lead to serious problems in the future.  Why shouldn't markets rally with more of that in prospect?

In the short term, markets don't care about dire consequences that are somewhere down the road. They rally based on liquidity and money printing provides it for them. While the news that the EU is going to recapitalize its banks sounds positive, there is little if any discussion in any article about where the money is going to come from. For the answer, picture a giant printing press spewing out fresh euro bills at break net speed. Investors should also expect a lot of nationalizations as part of this process. Belgium has just announced it will take over failed bank Dexia (described by the news media as "troubled"). Dexia is the largest bank in the country.

Market volatility is common during credit crises. Investors should expect continued market selloffs interspersed with big rallies. Ultimately, money printing will not save the day however because real value can't be created out of thin air. The day that will happen, is the day that PIIGS will fly. 

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.

The Twisted Logic of the Fed's New Policy Move

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.

At the end of its September two-day meeting, the Federal Reserve announced it latest attempt to revive  the U.S. economy -- Operation Twist. This Fed launched its first program to stimulate the economy four years ago at its September 2007 meeting and the economy is still in the doldrums. While the Fed hasn't yet begun QE III, the Bank of England looks like it is about to return to this form of money printing.

The Operation Twist announcement didn't come as a surprise to the markets. It was obviously leaked to the press days ago and articles about it were common in mainstream news outlets earlier this week.  The name comes from a dance popularized by Chubby Checker in the early 1960s -- the last time the Fed engaged in a similar policy move. The rotund Mr. Checker is an appropriate symbol for the bloated U.S. national debt,  the bloated U.S. budget deficit and the bloated Federal Reserve balance sheet, which has been swollen by huge amounts of money printing. The Twist itself involves expending lots of energy going back and forth, but getting nowhere -- the very picture of the 2011 Fed.

In the current Operation Twist, the Fed is planning on selling $400 billion of short-term debt and buying treasuries with 6 to 30 year maturities. The idea is to drive down longer-term interest rates in order to stimulate the economy. Many mortgage and credit card interest rates are set based on the yield of the 10-year U.S. government bond. The 10-year interest rate is already at a record low after falling below the low of 1.95% established 70 years ago in 1941. Real U.S. interest rates (those adjusted for inflation) have been negative for some time. Thirty-year and 15-year fixed mortgage  were already at their lowest historical rates earlier this month. There is no evidence that interest rates are holding back consumers from making purchases. Lack of jobs and income are the problem and the Fed's latest move isn't likely to improve either.

Across the pond, the Bank of England looks like it will start another round of QE (quantitative easing) later this fall. The BOE already printed 200 billion British pounds in 2009 and 2010 for its initial program. This is small compared to the $2 trillion increase in the U.S. Fed balance sheet.  It is universally acknowledged that the UK economy is weakening and the BOE is willing to take this risky inflationary approach even though British consumer prices have increased by 4.5% in the last year. Real interest rates are negative there as well.

The Fed is probably anxious to start its next round of QE as well, but political pressure is holding it back.  Republican leaders in congress sent a letter to Ben Bernanke to "resist further extraordinary interventions in the U.S. economy". Apparently, they are worried that money printing and negative real interest rates will lead to serious inflation -- just as they always have throughout history. The anemic Operation Twist certainly isn't in the category of extraordinary. If anything, it's sub-ordinary. Apparently the stock market thought so with the Dow Industrials falling 284 points or 2.5%, the S&P 500 down 35 points or 2.9% and Nasdaq closing 52 points or 2.0% lower.


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.

Economic Reports Indicate U.S.Economy Heading Down

 

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.

Default notices on U.S. home mortgages rose 33% in July. Retail sales and food services rose only 0.0% -- adjusted for inflation they were negative. The CPI inflation measure for August came in at 0.4%, almost as high as it was in July.  Weekly jobless claims rose again this week, coming in at 428,000.  All are pointing to an economy in trouble.

The Great Recession began in the housing market after subprime loans started to default in large numbers in 2007. The U.S. economy will continue to have difficulties until all the excesses are ringed out of house prices. Government policy has instead been geared toward stabilizing the market with temporary fixes. The Federal Reserve instituted a number of programs to funnel money into the mortgage markets to protect the banks that had too much exposure to real estate loans and the Obama administration has created programs like HAMP (Home Affordable Mortgage Program) to lower the foreclosure rate. Banks themselves have avoided or delayed foreclosures as long as possible because they don't want the properties on their books. All the government's efforts have certainly slowed down the rate of foreclosures and that may ultimately be all that they accomplish. A 33% increase of foreclosure notices in July indicates a new wave of foreclosures is likely next year.

Meanwhile, U.S. retail sales are declining if you take inflation into account. Retail sales increased strongly with rising home prices in the first years of the 2000s, but after the housing market turned south they have yet to recover. They have been held up by trillion dollar plus annual federal budget deficits, Federal Reserve money printing, and government stimulus programs including the 'Cash for Clunkers' gift to the auto industry. Despite all of these efforts, retail sales and food services were up 0.0% in July (the same 0.0% for jobs created in August). The mainstream media reported 0.1%, but this is only the retail sales component of the report. The report is not adjusted for inflation, so even if retail sales rose 10% a year, but inflation was also 10%, there would be no actual growth (although that is not the story you would get from mainstream news sources).

Retail sales are crucial for the U.S. economy because they make up approximately 70% of GDP. If they don't grow in real terms (after being adjusted for inflation), it is difficult for the economy to grow. To get a quick read on how the retail sales numbers are being impacted by rising prices all that is necessary is to look at the gasoline sales subcomponent. There is no reason to think Americans are using a lot more gasoline from year to year, if anything less is being used. Yet, year over year gasoline sales are up 20.8%. This is caused by inflation. Retail sales and food services overall were up 7.2% year over year. Adjusted for a realistic inflation rate, this number would be somewhat negative. 

That is not to say that the government is reporting an inflation rate that high. The just released CPI for August was 0.4% or 4.8% on an annualized basis. It was 0.5% in July or 6.0% on an annualized basis. Alternative inflation measures from ShadowStats.com indicate actual U.S. inflation is several percentage points higher than the official numbers indicate. ShadowStats.com calculates its inflation numbers the same way the U.S. government did in the 1970s. Since there have been many changes in how U.S. inflation is determined since then, it is not meaningful to compare current numbers to the past ones since doing so is like comparing apples to oranges. The ShadowStats numbers indicate that inflation is much higher now or if you don’t accept that, then you are left with the absurd conclusion that high inflation didn’t exist in the 1970s (you will find that this is the case if you use current methods to recalculate the 1970s inflation numbers).

The other major drag on the U.S. economy -- lack of jobs -- also seems to be getting worse. Weekly claims rose again this week to 428,000. Over 400,000 is considered a recessionary level. With the exception of a few weeks, these have been continually over 400,000 for almost three years now, indicating an ongoing recession (despite all the claims to the contrary of a recovery). The trend is actually worse than it appears however. These numbers should strongly regress toward the mean (move back to the long-term average), but haven't as of yet. As a recession goes on and on eventually everyone that is going to be laid off eventually has been and that should cause this number to decline for statistical reasons even if the economy isn't improving. That it has managed to stay at such high levels for almost three years is truly amazing.

The overall picture provided by U.S. economic reports indicates a flat or declining economy with rising inflation. Little progress seems to have been made in the last three years. The new credit crisis arising in Europe is only going to make matters worse. The U.S. economy was merely weak before Lehman Brothers defaulted, but it fell off a cliff after that.

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.

Risks of Market Contagion from a Greek Default

 

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 U.S. markets closed slightly up on Monday September 12th, panic reigned in Europe. The risks of a hard default by Greece reached 98% according to one model. Interest rates in Greece were spiraling out of control (the two-year government yield hit almost 70%) and credit default swaps on European sovereign and bank debt reached record levels again.

While Greece is a small economy and there are only two major countries --- France and Germany -- that hold substantial amounts of Greek government and corporate debt, this is only the very tip of the financial iceberg that threatens a titanic like sinking of world markets similar to what occurred during the 2008 Credit Crisis when Lehman Brothers collapsed. Problems in Greece are shared by two other small national economies, Ireland and Portugal, and by two much large economies, Spain and Italy. The Italian economy is roughly the size of the UK economy. It is too big to bail out. Can you imagine the UK defaulting and there being enough money available for an international rescue? If not, don't assume that problems with Italy can be fixed either. Spain is also too large to rescue.

Country defaults have implications well beyond their borders because large international banks have exposure to loans in them. In the global financial system, all large international banks are interconnected. Big banks such as Deutsche Bank, Société Générale, and Bank Paribas have substantial relationships with U.S. banks. The large banks are still in a weakened state from the 2008 crisis. This is showing up in British banks, which like the U.S. banks have limited exposure to Greek debt, and in Bank of America. Credit default swaps have reached record levels for some British banks and Bank of America's stock price keeps dropping.

The Greek default, and this will happen one way or the other at this point, will be similar to the demise of Lehman  in 2008. Contagion spread throughout the world financial system. In the U.S. the close to trillion dollar TARP program had to be instituted to hold up the banking system. In total, as much as $11 trillion in programs (the Federal Reserve alone had half a dozen major ones) had to be implemented to patch things up. The will for such an effort no longer exists, which will mute whatever response the authorities come up with will be delayed and muted. After Greece, something will have to be done with Ireland, Portugal, Spain and Italy. Those who think that the U.S. markets will be isolated from these events are at best engaging in wishful thinking and at worst are purposely misinforming the public.

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.

Will You Become an Inflation Victim? Take this Simple Quiz

The 'Helicopter Economics Investing Guide' is meant to help educate the public 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 offical blog of the New York Investing meetup.


Recently, San Francisco Fed President John Williams assured the public that there won’t be runaway inflation in the United States. His remarks follow a long litany of comments from  Federal Reserve officials that inflation is under control, inflation is low, and other variations of there simply is no inflation.  People who know inflation history, and this includes very few people alive today, are getting little comfort from these remarks. Central bank officials have repeatedly assured the public that there is no inflation in the past despite inflation obviously existing. One of the most vocal and sustained denials took place in Weimar, Germany in the 1920s. The central bank, the treasury department and top economists all agreed that inflation wasn’t a problem. It eventually reached 100 trillion percent.

Americans just have to open their eyes to see that inflation exists. Gasoline prices have risen from a $1.60 a gallon at the bottom of the Credit Crisis to almost $4.00 today. A number of food commodities, including sugar and coffee are having sustained price rises, and food prices in the supermarket are noticeably higher. I have a friend who records all of his family’s food purchases in Quicken and even though they are eating the same foods in the same quantity, the amount they are spending has gone up 10% in the last year.  Prices of clothing are also rising because commodity cotton prices broke a 150-year high recently. Copper, which has the widest of uses of all metals, has also hit an all-time high earlier this year.

Yet, the Fed tells the public not to worry as it continues one program of money printing after another. Even though this has always resulted in inflation in the past (the basic laws of arithmetic would have to be violated if it didn’t), they claim things are different this time. The continually fall back on the argument that there is a lot of slack in the economy and since U.S. unemployment is around 9%, wages can’t rise and this prevents inflation. Unfortunately, real world observations of past major inflations indicate how absurd this line of reasoning is. Unemployment in Weimar, Germany rose to 23% as their inflation rate reached the trillion percent level. Slack in the German economy was nothing however compared to Zimbabwe in the early 2000s. Unemployment there reached 94% and literally nobody in the entire country had a job. The inflation rate in Zimbabwe is estimated to have been at the sextillion percent level (a number so huge it might as well be infinity).

Before inflation really gets out of control, take the  following quiz to find out how well-informed you are about inflation investments and how your portfolio will be affected by it.

QUIZ

ANSWER TRUE OR FALSE

1. Safe investments like money market accounts, CDs and government bonds are just as good during high inflation as other times.
2. TIPS (Treasury Inflation Protected Securities) will at the very least maintain my capital during inflation.
3. Buy and hold in the stock market is an effective wealth building strategy during high inflation.
4. The higher the inflation rate, the better residential real estate is as an inflation hedge.
5. The U.S. dollar is the strongest currency in the world and will remain so during a period of high inflation.
6. If I have 5% of my portfolio in gold, my assets are protected from high inflation.
7. Of all possible inflation hedges, gold will provide the biggest return during high inflation.
8. When inflation is taking off, commodity prices will rise at the same rate as inflation.
9. When a government imposes wage and price controls, you can assume the inflation rate will come down and stay down.  
10.  Speculators are the cause of high prices during inflation.

WHICH INVESTMENT WOULD YOU RATHER OWN DURING HIGH INFLATION?

11. The U.S. dollar or the Australian dollar
12. A U.S. treasury bond or a collectible Pez dispenser.
13. A house in the Chicago suburbs or a 100-acre farm in Iowa
14. A 5-year CD or a copper mining stock
15.  Utility stocks or commodity oil
16. Municipal bonds or Thai grade B rice
17. TIPS or a set of silverware
18. Long positions in U.S. treasuries or short positions in U.S. treasuries
19. A money market account or a gold ETF (exchange traded fund)
20. British stocks or an antique map of England

HOW TO GRADE YOUR QUIZ

The answers to questions 1 through 10 are all false. The correct answers for questions 11 through 20 are the second choice. If you scored between 0 and 5, don’t be critical the next time you see a homeless person looking for food in a public garbage can. If you scored between 6 and 10, you will probably remain in your home, but won’t be able to heat it that much and your cupboards won’t be well stocked. If you scored between 11 and 15, you will get through a period of high inflation relatively unscathed. If you scored between 16 and 20, go to a neighborhood of high-priced homes (assuming you don’t already live in one), find someone who scored under 5 on the quiz and tell him that you will be living in his house in the future.

Explanations for questions 1 through 10: People who own liquid investment, such as money market accounts, CDs and bonds will lose money during inflation. In the worst cases, they will lose everything. TIPS are not an effective protection because their returns are based on official inflation rates and the U.S. government has been underreporting inflation since 1983. Stock prices tend to go sideways during inflationary periods and can be highly volatile. Residential real estate is a very poor investment during inflation because it can become extremely cash flow negative because of rising taxes and maintenance costs. The U.S. dollar has not been the strongest currency in decades and it went down against every major currency between 2000 and 2010. It is good to hold gold during high inflation, but 5% isn’t enough. Gold does not produce the highest inflationary returns, silver and many other investments can outperform it. It does produce the most reliable returns however. Commodity prices actually rise much faster than the overall inflation rate (examples were cited in the beginning of the article). Wage and price controls almost always fail. The only work if government money printing is permanently halted at the same time that they are imposed. Speculators don’t cause high prices, but along with foreigners, they are universally blamed for inflation. Central bank money printing is the cause of high prices.

Explanations for questions 11 through 20:  In general, tangible investments are preferred to liquid investments during inflation, so if the choice is between a money market account, CD, or bond versus a commodity or commodity related stock, the commodity is the best investment. Antiques and collectibles are also better investments that liquid investments. Of all the public currencies in the world, the Australian dollar most closely tracks price changes in gold, so it is the top choice during inflation. Farmland is the best real estate investment during inflation. Interest rates go up during inflation, so the way to make money in bonds is to short them, not own them.

Disclosure: Author does not own any specific investments cited in this article, but does hold some U.S dollars.

Daryl Montgomery
Author: Inflation Investing – A Guide for the 2010s
http://www.amazon.com/Inflation-Investing-Guide-2010s-ebook/dp/B0051GU06W/ref=sr_1_4?s=books&ie=UTF8&qid=1306940501&sr=1-4

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security

 

The Fed's Minimum Price Stability, Maximum Unemployment Policy

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 Fed says it's worried about deflation and high unemployment. So in order to tackle these two problems it's going to do more of the same things that lead to them.

In its post meeting statement yesterday, the FOMC said that inflation is 'somewhat below' levels consistent with its congressional mandate for stable prices.  Since the official inflation rate is positive, this indicates that under no circumstance should prices actually remain stable in the U.S. It also means that prices have to increase by more than the amount they are rising now. This of course leads to long-term dollar devaluation and indeed the dollar has lost 96% of its value since the Fed has been in business. They obviously can't wait to lop off the remaining 4%. Having a worthless currency is obviously a good thing as far as the Fed is concerned (you might disagree when you have to pay $5,000 for a loaf of bread). Inflation-sensitive gold hit its fifth record high in as many days on the news and was pushing $1300 an ounce this morning.

It order to tackle the non-existent deflation problem, the Fed intimated that more quantitative easing - also known as money printing - is on the way. There is no case in financial history when excess money printing hasn't eventually led to higher consumer inflation and it has frequently led to hyperinflation. The Fed has already done a lot of 'printing' and the ever increasing price of gold is showing the dollar losing value right in front of our eyes. However, the see no inflation, hear no inflation, and speak no inflation Fed ignores the gold market. Instead they are looking at ever dropping interest rates - the two-year treasury hit another record low after the meeting. Falling interest rates are being caused by all the new money they are manufacturing because bonds are being bought with some of it and this drives their price up and rates down. Using some form of inverted, twisted thinking, they view a market reaction caused by excess money printing as a sign of deflation.

The Fed first lowered its Funds rate to zero in 2008. With help from the U.S. treasury, they have engaged in an expansionary money creating policy since then as well. Unemployment is now much higher than when they started these moves and is stuck around the 10% range if you believe the official numbers (if not, it's much higher). After the worst recession since the 1930s, the economy is stuck in neutral, if you believe the official numbers (if not, we have already entered another recession). So the Fed's solution is to ratchet up the same policies that have failed over and over again and they claim somehow they will work now. It is far more likely the Fed's actions will nstead lead to minimum price stability and maximum unemployment.

Disclosure: No positions.

Daryl Montgomery
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.

Is the Bond Market Setting Up for Another Credit Crisis?

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.


Spreads on high yield bonds and U.S. treasuries are narrowing. Junk bond issuance is at an all-time high because excess liquidity is lowering risk aversion. Who is buying all the bonds is not particularly clear however. But don't worry, just as they did before the last Credit Crisis, the economic elite is telling us there is nothing to worry about this time either.

When there is too much money sloshing around the global financial system, the distortion shows up clearly in the bond market because it's an insider's game. The average investor isn't exactly trading credit default swaps in his or her 401K. According to a recent Wall Street Journal report, less than $29 billion has gone into high yield bond funds in the last 20 months. Yet Dealogic data indicates that $172 billion of junk bonds have been issued in just 2010 alone. Spreads over 10-year treasuries are now around 6%, but have been somewhat lower during the summer. In 2007, spreads fell to around 2% and this indicated all common sense had abandoned the bond market. The inevitable collapse followed and at the height of the Credit Crisis, junk/treasury spreads were over 20%.

One of the major determinants of yields on junk bonds is the danger of default. The economy is in much worse shape now than it was in 2007, even though we were just told yesterday by the NBER that the recession ended 15 months ago (boy, that sure is a timely announcement). So we should not get as low as a 2% spread between junk and U.S. treasuries like we did last time. Less risk of failure because of government bailouts should not be assumed either. Few issuers of junk bonds would be considered too-big-to-fail and the government blank check for bailouts is either over or it soon will be.

There is also the mystery of why as more and more bonds are being issued, less and less trading activity is taking place. Bloomberg economist Michael McDonough recently reported U.S. treasury trading is down and so is junk bond trading. Trading in stocks on the NYSE is also down as the market has risen. So how can prices be going up when there is a greater supply of bonds, but apparently less demand?  This is not really possible, so there has to be missing information. Now who would have access to vast sums of money and the ability to hide their activities in the market?

A narrow spread between junk and treasuries is something to keep an eye on and to worry about. It is a good indicator of whether or not central banks have injected so much liquidity into the financial system that they have risked another credit crisis. It is not possible to say where the exact point is where the spread is too low, although it is now definitely somewhere well above 2%. If we haven't reached it yet, we are getting close.

Disclosure: No positions.

Daryl Montgomery
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.

Will Stocks Continue to Rally After Quadruple Witch?

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.


Today is one of four days during the year when index futures, index options, stock options and stock futures all expire. The market has rallied throughout September into the quadruple witch, but will it continue to do so?

As has been the case with every rally since the bottom in 2009, volume this September has been below average on the Dow Industrials. Low volume is an indicator of lack of enthusiasm for a trend and indicates the trend is likely to reverse soon. Nevertheless, stocks have managed to defy the lack of buying support and hold up for almost a year and a half now. This is theoretically impossible in a free market. It is very possible in a manipulated market however where one or a few large players control the game. In such circumstances, some tip sheet on Federal Reserve liquidity pumping would be the best guide to be used for trading stocks.

The mainstream media has been giving the rally as much support as possible as well. Weekly unemployment claims which invariably fall around holiday weeks, not surprisingly went down the week before and after Labor Day. Instead of reporting this as business as usual, the cheerleading media claimed it was new evidence of an improving economy. Retail sales supposedly had a minor jump in August, although the report was not credible. The smoking gun was the auto component which barely declined over August 2009 when Cash for Clunkers was giving auto sales a huge boost. Independent industry sources showed a huge drop in sales year over year, but somehow government statisticians know nothing about it. Both reports were replete with missing data, so some component numbers were merely wishful thinking estimates. The mainstream media didn't manage to report this key information. A consumer confidence survey today indicated confidence dropped to its lowest level since August 2009. The cause for the drop was consumers getting really gloomy about the future prospects for the economy. Apparently they are increasingly tuning out the information they are getting from the government/media complex and believing what they see with their own eyes instead.

So even though the economy is continuing to deteriorate, government statisticians are doing their best to hide this from the public. The mainstream media is doing its best to help them out by not questioning any number they produce no matter how unreliable or unbelievable it is. The Fed and other central banks and treasuries (think the one trillion dollar euro-TARP program) are doing their best to keep the world financial system afloat in a sea of liquidity. The most obvious evidence for this is a range of assets - stocks, bonds, and commodities - are all rising at once. This happens if there is more money in the system, otherwise traders would need to sell one asset in order to get funds to buy another. When they can bid up every asset, there has to be more available money and less risk aversion, which makes no sense given all the problems that currently exist.

Given the current environment, stocks can certainly continue to go up. Investors should assume the Fed will do everything possible until at least the election on November 2nd to make the market look good. There is no free lunch however. While liquidity driven markets can go higher and last longer than anyone thinks possible, they can also drop faster and much further than anyone would imagine. And this can take place suddenly. Constantly keeping the liquidity trough full also risks massive and sudden inflation. Don't expect to hear about this from the mainstream media though because they will be too busy telling you not to worry because everyone knows that liquidity fattened pigs can fly - or at least that's what the latest government report said.

Disclosure: No positions

Daryl Montgomery
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.

Japan and U.S. Offer More 'Stimulus You Can Believe In'

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 mainstream media on Monday was hyping a Japanese expansion of a low-interest loan program to financial institutions after talking up Fed Chair Ben Bernanke's statement on Friday that the Fed "will do all that it can" to support the economy. Japanese stocks and U.S. stocks respectively rallied strongly on these essentially negative news items.

The Japanese have been trying to fix their economy for twenty years. They have engaged in one stimulus program after another after another after another after another and it's still dead in the water. Despite the repeated failure of the approach they have taken, this doesn't deter them from engaging in the same behavior again. There is no reason to believe things will be any different this time. Nevertheless, the mainstream media cues the cheerleaders and dutifully reports this as good news, instead of pointing out that the need for a new stimulus program indicates all the previous ones have not worked. That sounds like bad news to me.

The U.S. monetary and fiscal authorities seem to be doing their best to imitate the Japanese. The Fed though has only had three years to follow them on their road to perpetual economic failure. Bernanke's statement on Friday was made from the Fed's annual meeting at Jackson Hole, Wyoming, which the media described as a 'confab' (confab is short for confabulation, which in psychiatry means 'the replacement of a gap in a person's memory by a falsification that he or she believes to be true' - unquestionably an important concept when dealing with establishment economists). What exactly was Bernanke implying when he said that the Fed would be doing all that it can to support the economy? Does this mean that it wasn't doing all that it could have done previously? In at least one sense the answer to that question is yes. The Fed could have opened the floodgates of uncontrolled money-printing and Bernanke was intimating that this is what is going to be happening in the future.

While the Fed and its cohorts in the economic community continue to maintain that there will be no double-dip recession, Intel threw some more cold water on this assumption on Friday. The tech bellwether sharply lowered its third quarter earnings expectations after raising them only a month earlier. PC sales have been running below previous forecasts. This is a strong blow to the U.S. economy since computer and software sales were up 24.9% in the second quarter GDP report. A drop to a negative number for this category could turn the entire third quarter GDP negative. But don't worry, Ben Bernanke will be handling the situation and we all know what an excellent job he's done previously in fixing the economy. Wait, isn't that a confabulation?

Disclosure: No positions

Daryl Montgomery
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.

Reconciling Bad Economic Data and Good Earnings

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.


So far this earnings season, company reports indicate that business is going gangbusters. U.S. economic reports are painting exactly the opposite picture however. This may not be as contradictory as it appears on the surface.

As for earnings, Intel reported record numbers yesterday, after Alcoa upgraded its forecast for global aluminum sales and U.S. railroad company CSX said shipments were up considerably. This morning however U.S. retail sales numbers disappointed again, falling 0.5% in June following a 1.1% drop in May. Mortgages for home purchases fell to a 14-year low. According to the non-farms payroll reports, close to a million people net left the U.S. labor market in May and June because jobs were so scarce that they simply gave up looking.  Later today, the Federal Reserve is expected to lower its expectations for second half U.S. economic growth.

One of the important things to note is that both Intel and Alcoa are global companies. While many people assume that the U.S. is Intel's major market, it isn't. East Asia dominates Intel's sales. Strong Intel numbers generally indicate a robust East Asian economy. Growth has indeed been strong there. Intel's biggest growth sector by far was servers, which were up 170%. These are used for the Internet. Intel also cited cloud computing as a driver of sales. It is possible for a new technology to grow while the economy declines. The best example of this is the growth of radio during the Great Depression 1930s.

As for Alcoa, its projections may prove to be much too bullish. Industrial metals appear weak across the board and this indicates global manufacturing could turn negative in the next few months. CSX's good numbers were dependent on auto shipments. That market in the U.S. peaked in the third quarter of 2009 because of the Cash for Clunkers program. In the June retail sales report, autos were the weakest component.

Investors should not make judgments for the U.S. economy based on figures for global companies, especially when the U.S. is only a minority of their business. The U.S. economy can be much weaker than Asian economies. Asia was in the driver seat pulling the world out of the Credit Crisis recession and the U.S. followed. The U.S. may lead once again though bringing the world into the next recession.

Disclosure: No positions

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

What's Driving Today's Market Rally

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.


Major European stock indices were up two to three percent today after Asian indices rose around one percent last night. The U.S. markets then had a strong opening after the three-day holiday weekend. Mainstream media is citing bargain hunting as the source of the rally, whereas money-pumping operations to support the euro is likely the major contributor to the market's bullish behavior.

Stocks were devastated in the last two weeks and some rally at this point is reasonable in order to resolve an oversold condition. Strong buying in the U.S. though would be inconsistent with the bear market signal being giving by the S&P 500 on Friday and the small cap Russell 2000 having experienced a bear market loss of over 20% the same day. This is not the type of market environment that traders can't wait to plunge into on the long side. Liquidity pumping by the major central banks would be most effective (and likely) at a key market juncture like this however.

Central bank efforts to support a faltering global financial system began in earnest on Sunday May 9th after the Flash Crash three days earlier. The EU announced its $915 billion euro rescue plan and at the same time the U.S. Fed opened unlimited liquidity swap facilities with the European Central Bank, the Bank of England and the Swiss National Bank. A swap facility up to $30 billion was opened with the Bank of Canada. The Fed stated, "These facilities are designed to help improve liquidity conditions" and that the Bank of Japan was considering similar measures. The swap arrangements were authorized until January 2011.

Stock markets around the world then skyrocketed on Monday, May 10th since increased liquidity shows up immediately in stock prices. Investors should expect intermittent market impact both from euro rescue money and swap generated liquidity for the next few months. For the full text of the Fed's announcement, see: http://www.federalreserve.gov/newsevents/press/monetary/20100509a.htm.

It is fortunate for the markets that liquidity is on tap when needed. Not only is the technical picture of the market deteriorating, but the economic news isn't supporting stocks either. Little noticed last Friday was the announcement of a decline of 1.4% in U.S. industrial production. The ISM Manufacturing index for June, which came in at 56.2, indicated a slowing expansion (over 50 indicates growth). Almost every component, except for those related to inventories, was down. New orders, an indication of future activity, dropped 7.2 from the previous month. The ISM Service index fell to 53.8, which was below forecast. The employment component was 49.7 dropping below 50 and indicating job losses. The service sector is four times bigger than the manufacturing sector in the U.S.

Investors should enjoy the rally while is lasts. The rally after the flash crash in May lasted four days. Within ten days, stocks were lower than they had been during the crash. Liquidity induced rallies can be powerful, but they don't last very long.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Market Continues Choppy Trading

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.


Choppy trading is a sign of a troubled market. Within the last ten days, U.S. stocks have had a great deal of difficulty deciding which way they wish to go. As of today, the Nasdaq has either gapped up or down seven days in a row on the open. Intraday gaps, which are very rare and indicate a great deal of volatility, have also occurred.  This type of trading usually takes place at market tops or bottoms.

The problems in the U.S. stock market began intraday on Thursday, May 6th with the sudden market drop and rise around 3:00PM. In a span of approximately 16 minutes, there were multiple gaps on the downside and then multiple gaps on the upside on the major U.S. market indices on the one-minute chart. The Dow Jones Industrial Average moved 700 points in both directions in that short period. Fewer gaps appear on the five-minute and fifteen minute charts, but they are more pronounced. This was followed by a noticeable intra-day gap on the downside on all the very short-term charts on May 7th. Then there was a massive gap up on the open on Monday, May 10th, with the Nasdaq opening around 100 points higher than its Friday close. The ECB (European Central Bank) has admitted to a massive liquidity injection at that time and this money flowed directly into the stock market. Other central banks were probably involved as well.

Looking at the charts it can be seen that Nasdaq then gapped down on Tuesday, up on Wednesday, and down on Thursday on the open. The gap down on Tuesday was significant, but the other two were relatively minor and not really out of the ordinary. Then last Friday, there was an almost 30-point drop on Nasdaq when stocks began trading. That is very much out of the business as usual range. After that, there was a small gap on Monday and a somewhat larger gap up today. The market suddenly turned around in the middle of the day yesterday while trying to fill the huge gap from May 6th. This is atypical behavior (the gap was only partially filled) and has all the earmarks of central bank interference.

Markets like to trade in continuous patterns. When gaps occur, they almost always get filled (trading takes place in the price range that was skipped because of the gap). This commonly happens within a few days, but it can take weeks, months or even years.  Investors in general don't like choppy markets, although they are a boon to short-term traders. Trending markets tend to have smoother price movements and investors should be on the lookout for a return to this type of less volatile environment.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Fed Will Leave Rates at Zero Until Inflation Shows 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.


The Federal Reserve left the fed funds rate in the zero to 0.25% range at its April meeting. This is the 16th month that the Fed has maintained rates at an all-time low. While the Fed was a bit more upbeat about the economy than it has been at recent meetings, it still pledged to keep rates near zero "for an extended period of time".

When it comes to the Fed and other government representatives, investors would be best off by paying attention to what they do and not to what they say. The Fed was certainly more upbeat in its statement from the April meeting than it was in previous meetings. It noted that "economic activity has continued to strengthen and that the labor market is beginning to improve","growth in household spending has picked up recently" and  "business spending on equipment and software has risen significantly". You would think happy days were here again and short-term rates will be 5% before you know it. Well maybe not, it turns out.

While strong economic growth leads to inflation, apparantly there is no risk of that (inflation that is) as far as the Fed is concerned. The Fed went on to say that "with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time". So the Fed seems to be talking out of both sides of its mouth. Either growth is not sustainable in the long-run and it thinks this will keep inflation subdued or the Fed has pumped so much money into the financial system that this is creating economic expansion (at least for the moment) and inflation will follow.

The first scenario was seen in Japan during the last two decades, especially after its two-year recession in the early 1990s. The economy was supposedly recovering nicely without inflation for a few years. Instead, it gradually fell into the abyss and a deflationary spiral. In the second case, uncontrollable inflation is possible - and this can take place with a great deal of resource slack. Rapidly declining and eventual collapse of resource utilization is the marker of hyperinflation. Fed chair Bernanke should tell Zimbabwe that it couldn't have possibly had the second highest inflation rate in world history, sextillion percent, because it had an unemployment rate of 94%. Weimar Germany, with a mere 100 trillion percent inflation rate, had unemployment that reached almost 25%.

The Fed statement also had two telling comments that provide significant insight in the Fed's thinking. These were, "financial market conditions remain supportive of economic growth" and "bank lending continues to contract". Taken together these indicate that the financial conditions that are supportive are the Fed's low interest rates and the high prices of stocks - the paper economy. While the paper economy is going great, as indeed it was before the Credit Crisis and during every other bubble in history, the real economy is struggling. It can't function well without adequate credit from banks. In other words, the Fed's positive view of the economy is based on economic make believe.

If the Fed really believed the economy was improving, it would be raising rates or at least getting ready to do so and not say it was maintaining its ZIRP (zero interest rate policy) for a long time. As I have documented in previous articles, there is usually a two to three year lag from the end of a recession until the Fed starts raising rates. If we assume optimistically that the recession ended in July 2009, that would take us until at least July 2011 before rates went up. Any rate rise before that date would indicate significant inflation risk and a rate rise after July 2012 would indicate a serious deflation problem.  In either case, the Fed's response will be too little, too late.

Disclosure: None Relevant

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Ford Still Financially Troubled Despite Q1 Earnings

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.


Debt ridden Ford Motor earned $2.1 billion in the first quarter or 50 cents a share. Mainstream media reported this as "another sign the economy is improving as people spend more on big-ticket items like cars". Unstated was which economy was improving or that those people were in China. Nor did any report mention that Ford stock has a negative book value of minus $2.32 per share.

What struck me immediately about Ford's 2010 Q1 earnings report was a major inconsistency with the Q1 earnings report for 2009. Ford lost $1.4 billion, or 60 cents per share in the same period last year. This implies that there were 2.3 billion shares outstanding twelve months ago. Based on today's earnings numbers there appear to be 4.2 billion shares outstanding. Ford did issue an additional 300 million plus shares of stock last May and exchanged $4.3 billion in convertible debt for 468 million shares of common stock in the first half of 2009. News reports in May 2009 indicated it had 2.9 billion shares outstanding before the new stock was sold. Today, Ford supposedly has 3.4 billion shares of stock. Off hand, I would say these numbers don't appear to match up.

It is quite amazing that Ford did not sink into bankruptcy, as did General Motors and Chrysler. From 2006 to the first quarter of 2009, the company lost $31.4 billion. Actions taken by Ford in 2009 though are helping the bottom line today. The new shares it issued at the time were used to fund VEBA, the UAW run health car trust, and this saved the company from using real money for this purpose. Ford also worked out an agreement with the UAW that allowed it to lower its labor costs by $500 million annually. At the same time, Ford managed to lower its interest payments on its substantial debt by $500 million a year with its debt to stock conversion. Fortunately for the company, Ford is making a good share of its profits from its credit unit (not from selling cars), which earned a net profit of $528 million in the first quarter of 2010. Ford has the Fed's zero interest rate policy to thank for that.

As for sales, there was a huge increase - in China. Ford reported an 84 percent improvement there. As for North America, U.S. sales did climb 37 percent over last years exceptionally low levels. Part of this is due to Ford's market share rising nearly three percentage points thanks to problems at Toyota. Total U.S. auto sales in 2009 came in at 10.4 million, down from over 16 million before the recession began. Ford still sees sales in the 11.5 to 12.5 million range for 2010. This is still substantially below pre-recession levels. Investors should also ask themselves how much of those extra sales are due to federal government policy. If this is a recovery, it's not much of one. 

Ford (F) stock was down more that 9% on its earnings announcement in morning trade. It fell as low as $13.15. That's still a pretty high stock price for a company with a negative book value.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
 http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Past Recessions Provide Insight Into When the Fed Will Raise Rates

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 Federal Reserve left the fed funds rate in the zero to 0.25% range at its March meeting. This is the 15th month that the Fed has maintained rates at an all-time low. At the conclusion of the meeting the Fed stated that it will keep rates near zero "for an extended period of time", so no rate increase should be expected for at least several more months. Examining how the Fed reacted to past recessions can provide investors with some insight into when the Fed will actually change to a more restrictive interest rate policy this time around.

According to the official record, the previous U.S. recession took place between March 2001 and November 2001. This recession was unique in that it is the only one in U.S. history where consumer spending didn't drop and it was also one of the mildest recessions on record. Fed funds bottomed at 1.00% in June 2003 - 19 months after the recession was supposedly over. The backdrop was very low inflation. New reports of a jobless recovery were common even in the fall of 2003 and there was great concern at the time because the unemployment rate was at the 6% level (as opposed to 10% today). Fed funds remained at a low point for 11 months. So the Fed started raising its funds rate 30 months after the recession officially ended. If we optimistically assume that the current recession ended in July 2009 because GDP turned positive in the third quarter of the year, this would imply Fed funds would start rising around January 2012.

The recession before the one in the early 2000s took place between July 1990 and March 1991. Fed funds bottomed at 3.00% in September 1992 - 18 months after the recession officially ended. Jobless recovery was also a big news item in 1993. Commentators noted that payroll employment in the 7 previous U.S. recessions had increased on average around seven percent in the two-years following the business trough, but had barely budged in that time period after the 1990-1991 recession. The unemployment rate was around the 7% level. The backdrop was declining inflation. The fed started raising rates in February 1994, so the low rate was maintained for 16 months and this was 35 months after the recession was declared to be over. This would imply that the Fed will start raising rates around June 2012.

The prior recessionary period was the double dip recession that took place between January 1980 to July 1980 and July 1981 to November 1982. This recession was actually created by Federal Reserve policy and sent the U.S. industrial base into a decline from which it never recovered. Inflation was high and at its peak, so interest rates were at the start of a long-term decline. Fed chair Volcker kept raising Fed funds rates until they reached 20%. They last time that they were that high was October 1981. They were then lowered until they had fallen to 8.5% in December 1982. The funds rate was then raised until a new lowering cycle began in September 1984. The funds rate bottomed at 5.875% in August 1986. High fed funds rates did not cause our current recession, so this period of economic history is not necessarily relevant to today's situation. The recession did take place at the beginning of a multi-decade shift in interest rates and this is also occurring now, although we are at the bottom of the cycle and not at the top like we were in the early 1980s. Japan's experience since 1990 indicates that rates can remain at or near their low point for well over a decade.

Before our current recession, the worst post World War II recession occurred between November 1973 and March 1975. Inflation was high and rising during this time period, so interest rates were generally trending upward. Unemployment peaked at 9.0% in May 1975. The concept of jobless recovery was an unknown phenomenon. The fed funds rate reached a low of 4.75% in January and November 1976. The Fed started a consistently more restrictive interest rate policy 21 months after the recession ended. That would imply that April 2011 could be the first Fed funds rate increase this time around.

Historical examination indicates that when the Fed starts raising rates depends on when a recession occurs in the context of a longer-term inflationary/deflationary cycle. When the inflation rate has already been falling for a decade or more or is around its low point, it takes longer for a rate rise than it does in a rising inflationary environment. Two to three years after a U.S. recession has been declared officially ended seems to be the norm before a tighter interest rate environment begins regardless of the inflationary backdrop. If the Fed raises rates on the short side of this number, this will indicate we are heading into rapidly increasing inflation. If it takes more than three years, it will indicate the possibility of grinding deflation as has occurred in Japan since the 1990s. The first alternative is the proverbial devil and the second is the deep blue sea.

Disclosure: None

NEXT: The Dollar, Euro, Gold, Oil and Treasuries

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Watch What China Does and Not What It Says

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 Chinese have recently released statements indicating that they are not interested in buying gold and that they plan on remaining "responsible investors" in U.S. treasuries. China is not known for informing the market about what it is actually doing. It instead has a long history of keeping its actions carefully hidden. It would therefore be reasonable for investors to assume that China is buying gold and selling U.S. treasuries.

The case for China doing the opposite of what its official statements indicate goes well beyond mere assumption. When TIC (Treasury International Capital) data was released in November and December, the numbers indicated that China was a net seller of U.S. treasuries. This potentially explosive news got little mainstream media coverage. China also announced in April 2009, that its gold holdings were 76% higher than had been previously reported earlier in the decade. China didn't mention it was buying this extra gold while it was doing so. Don't expect it to announce its gold purchases in the future either.

In its announcement, the director of China's State Administration of Foreign Exchange stated that China is not interested in buying more gold because of its poor returns in the last 30 years. He didn't mention its excellent returns in the last 10 years or even over the last 40 years. A similar argument could have been made to not buy U.S. stocks in 1982 because of their abysmal returns in the previous 16 years. You would have missed out on an 1100% rally in the Dow. This type of argument is meant for the financially naive and unsophisticated.

The director went on to state that China did not want to politicize its trading in U.S. debt and wanted to remain a "responsible investor". It is not clear what charges he was responding to, nor who had made them. There have been attempts to explain away the TIC statistics from November and December by claiming that China was secretly buying U.S. treasuries indirectly through intermediaries in the UK and Hong Kong.  Since this would make China look like it was selling treasuries and potentially devalue its vast treasury hoard, this behavior would make no sense. Furthermore, if you accept that treasury purchases are being funneled clandestinely through intermediaries, it would be far more plausible to assert that the U.S. Federal Reserve has been buying treasuries through Caribbean island off-shore money havens as some bloggers have suggested. The Fed would have good reason to do this in order to hide the extent of its money printing activities.

Investors need to keep the simple rule of 'watch what they do and not what they say' in mind when interpreting the news. Talk is cheap and most governments will say whatever they have to in order to implement their plans.  The mainstream media dutifully reports whatever is said. Unfortunately, they are not very diligent in reporting on what is actually done. That is really the only news that matters and sometimes the only place you can find it is in the blogosphere.

Disclosure: None

NEXT: NovaGold, the Gold Market and the Euro

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Outlook for U.S. Treasuries

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.


Treasuries rallied the last week of February, which should be expected in a strong dollar environment. The rally in the U.S. dollar that started in early December (around the time that news of the problems in Greece began to surface) is ongoing and this will continue to be bullish for U.S. government bond prices and bearish for interest rates while it lasts. Inflation expectations cause the opposite outcome however. These two competing forces help explain why longer dated treasury interest rates have been trading in a bullish pattern since May 2009, but after a brief initial burst upward have traded sideways since that time. Current conditions indicate that a breakout rally to higher rates will probably have to wait a while longer.

In the intermediate and long-term, there are a number of significant risks to U.S. treasuries as well as most other government's bonds for that matter. Direct default is now on the table for smaller economies like Greece. Indirect default through inflation and currency devaluation is the risk for the major economies, such as the U.S., UK, and Japan. Some top mainstream economists, such as Nobel Prize winner Joseph Stiglitz and chief economics commentator for the Financial Times Martin Wolf, have recently made the case that the U.S. can't default on its debt because it owns a printing press. While this is technically true, it doesn't mean the paying back a bond investment with money that is worth much less than it was at the time when it was lent isn't a type of default. Why would anyone want to buy a government's bonds under such circumstances? Bill Gross, managing director at the world's largest bond fund PIMCO, refers to this type of default as stealth-default.  Gross has made the case that the risk of either type of default of government debt will cause government debt and corporate debt to have similar interest rates in the future. This would cause interest rates on government bonds to rise relative to corporates in the next few years.

In the short-term though bad economic news along with the strong dollar should keep U.S. treasury interest rates from rising. There have been a host of negative economic reports in the last couple of weeks on the banking sector, consumers, housing, and durable goods. The ISM Manufacturing Index released on March 1st was a disappointment and its component parts provide an excellent representation of the current push-me pull-you factors on U.S. interest rates. While manufacturing is still in an expansionary mode, new orders and production (indications of future activity) declined sharply and this is a bearish for interest rates. However, the prices paid component, which represents inflation, was the highest number in the February report as it was in the January report. This is bullish for interest rates.  

While the Federal Reserve has frequently announced that U.S. economy is in recovery, it has always followed this up with a statement about how it is going to keep interest rates low for a prolonged period of time. This would not be necessary in an economy that was actually recovering. When the Fed is talking out of both sides of its mouth, investors should pay attention to what it is doing and ignore what it is saying. A prolonged period of low interest rates is inflationary and this means long-term treasury rates will be going up. The only question is when.

Disclosure: None

NEXT: A Snapshot of the Energy Markets

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.