How Much Stimulus Will Be Done by China, the EU and UK?

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.

Much weaker than expected trade data out of China on Friday indicates more economic stimulus will be forthcoming there soon.  Even bigger stimulus is expected from the ECB as it revs up the printing presses to bail out Spain and Italy (unless Germany stops it of course). According to a recent released report, the recessionary economy in the UK may need massive doses of quantitative easing to recover.

Exports in China rose by only 1% year over year in July and this was well below forecasts of an increase of 8.6%. Imports were up 4.7%. For a country that has an export-based economy like China does, this is a serious problem. Like the U.S., Europe and Japan, China engaged in a massive amount of stimulus during the Credit Crisis in 2008/2009, spending $586 billion or 14 percent of its GDP in addition to cutting interest rates and lowering banking reserves.  This led to a big expansion of local government debt, a major housing bubble that has yet to burst and consumer inflation. Apparently, there are unfortunate side effects when governments apply a lot of economic stimulus (notice you rarely read about them in the mainstream media).
This time around, China has already cut interest rates twice and reserve requirement ratios for banks three times since November. Its economy has slowed for the last six quarters and probably by much more than official figures indicate (China's economic numbers should be taken with a grain of salt).
China is still in spectacular shape though compared to Japan, which had a massive trade deficit in the first half of 2012. Japan has been economically troubled for 22 years and despite zero percent interest rates and an unending number of stimulus measures its economy remains in the doldrums. While all the stimulus hasn't solved Japan's economic problems, it has led to a debt to GDP ratio of over 200% (worse than Greece's).
One reason China's exports are doing so poorly is the weakening economy in Europe. On Thursday, the ECB cut its growth forecasts and is now predicting the eurozone economy will contract by 0.3% in 2012.  They are still hopeful of slight growth in 2013 however. Maybe they think it will come from all the money they plan on printing to bail out Spain and Italy. The Eurozone is basically tapped out from all the bailouts it has already done in Greece, Portugal, and Ireland (Cyprus and banks in Spain are now on the list as well). Greece needs a third bailout and is struggling to make it through the month until it receives its next welfare payment in September. The situation there is potentially explosive. The IMF has stated Ireland will need another bailout by next spring.
When ECB President Draghi said on July 9th that the central bank will take any measures within its mandate to save the euro, the inevitable conclusion was that he was willing to engage in massive money printing. The amount of money needed for the huge bailouts that Spain and Italy would require simply doesn't exist so it has to be created out of thin air. The Draghi proposal is for the ECB to buy bonds, but the ECB has already tried buying bonds under the SMP program.  The moment the buying stopped, interest rates shot right back up. This approach is costly and only effective in the very short term — a typical government program. It won't prevent the Eurozone's failure, it will merely delay it and make it worse when it happens.
The UK is not part of the Eurozone, but its economy is also contracting. Citigroup economists have stated that the UK will need to print an additional £500 billion and lower interest rates to 0.25% to prevent continued stagnation. Apparently, they don't think there are serious risks if this approach is taken. Neither did the Weimar Germans in the early 1920s, the Zimbabweans in the 2000s, the Chinese in the 1940s, the Brazilians for most of the 20th century, the Yugoslavians in the 1990s or the Hungarians in 1946. In fact, countries that create hyperinflation always claim the risks of money printing are minimal before it takes place. And there are usually a large number of top economists that support this view.  

There are serious structural problems in the major economies today. The usual Keynesian quick fixes that have been applied since World War II no longer seem to work, nor will they. These have led to a world drowning in debt and all debtors eventually reach their borrowing limit. When this happens with countries, they then try to print their way to prosperity. History makes it quite clear that this doesn't work either. 

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.

July Jobs Report Shows U.S. Economic Statistics Are a Joke

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.

According to the Labor Department, the U.S. added 163,000 jobs in July. Also according to the Labor Department, the U.S. lost 195,000 jobs in July. So the U.S. economy is either doing OK or it's falling apart big time. Or maybe something between the two is happening. Confused? You should be.

Two separate surveys are used for the employment report. In one, they ask businesses about the amount of hiring they've done in the previous month and in the other the ask people whether or not they have a job. The amount of jobs created for the month is determined by the business survey and the unemployment rate from the survey of households. As more than one article on the July employment report pointed out today, "economists say the business survey is more reliable". So if you think you're unemployed, but an economist says you have a job, the economist is right.

The unemployment rate ticked up to 8.3% according to the household data.  The two surveys have frequently not seemed to match in the past with minimal job gains resulting in drops in the unemployment rate. The Labor Department explained that this occurred because millions of people have left the U.S. labor force since the "recovery" began in 2009 (150,000 more left in July). Even though these people are unemployed, they are not counted as unemployed and this makes the unemployment rate look better. Why millions of people would stop looking for work during a "recovery" has never been answered. Usually, this type of behavior takes place during depressions.

The Labor Department did not discuss the massive discrepancy between its two employment surveys in its press release. Instead it gave a rosy assessment of all the jobs created last month. This included 25,000 new jobs in manufacturing, even though the recent ISM Manufacturing report (a private survey) indicated U.S. manufacturing activity shrank last month.  So an industry that is losing business is hiring lots of new workers. That certainly makes a lot of sense all right.

One possible explanation for the discrepancy was that "inappropriate" statistical adjustments were made to the numbers in the business survey. While one should never rule out gross incompetence when discussing the output of the government statistical offices, a more cynical person might think that there was a purposeful effort to produce better numbers than actually exist because it's an election year. After all, those pesky downward revisions months later never get any notice from the press and the ugly truth can always be told later when no one is paying attention (and after they've voted).

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.

Central Banks Sucker the Market

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.

Three major central banks met on August 1st and 2nd and none of them took any decisive action. Markets in the U.S. and Europe have been rallying since late June on expected policy easing they've been promised by reports in the mainstream media. So far, empty talk is all the central banks have delivered.

Traders had high expectations for the Fed's monthly meeting on July 31st and August 1st. A week previously, news hit the wires (only a few moments before Apple's disastrous earnings were announced) that the Fed was definitely going to do some easing at this week's meeting. The source was the Wall Street Journal and they followed up with a front page article the next day. And what did the Fed do?  Nothing, zilch, nada. So much for the Wall Street Journal being a reliable source of investing information.

For the previous meeting in June, Goldman Sachs claimed the Fed was going to be doing quantitative easing (or maybe some other form of easing, but you would have to have read the entire coverage to find that out). What happened when QE wasn't forthcoming? The market hypsters came out of the woodwork with assurances that QE3 would be announced at the July/August meeting. Now that that hasn't happened either, we are hearing "just wait until September". You might as well wait for Godot. The only way the Fed will be doing QE before the election is if the financial crisis in the Europe gets out of hand. This will not stimulate the economy, but prevent a total collapse of the stock market (not a drop, but a total collapse).

The Bank of England and the ECB also met today. No rate changes from either of them (unlike the U.S. and Japan both have rates slightly above zero and they could lower them). The Bank of England is already doing QE2 and has been doing so since the fall of 2011. The UK is in a recession and QE has not stopped its economic decline.

Mario Draghi, the ECB chair and one of the biggest windbags to ever run a central bank, held a press conference after his meeting. He said that the ECB would undertake "outright" open market operations and would be using non-standard policy measures. Bonds rallied on the news. Unfortunately, only minutes later, Draghi was forced to backtrack on his boisterous pronouncements. He admitted that he was only providing "guidance" of what was going to occur in the future and details wouldn't be available for weeks. Draghi continued that even if the ECB was ready to act now, it would not have the grounds to do so. Someone should give that man a bagpipe.

How long the markets will continue to fall for promises of stimulus that never comes remains to be seen. Whatever happens, there is no reason be confident that things will be getting better. If the Fed could fix the U.S. economy, it would already have done so. If the ECB could solve Europe's debt crisis, it also would have already done so. Doing more of the same is not going to work, so it's not worth waiting for cental bank action as is. Eventually, the markets will figure this out.

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.

Why Quantitative Easing Won't Happen Now

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.

Quantitative easing is off the table for the Fed at the moment because of Friday's GDP report. According to the Commerce Department U.S. second quarter GDP growth was 1.5%, which is mediocre, but not bad enough to justify another round of money printing stimulus.

The stock market has been juiced up on a number of occasions since June on rumors of impending QE3.  There is always connected to phrase like "the Fed will do more to help the economy." The mainstream press never raises the question of why does the Fed need to do more to help the economy. If its program worked, the economy should have recovered. If they don't, doing more of the same thing isn't likely to accomplish much. A need for a third round of QE certainly implies that the first two weren't effective — at least in creating economic growth.  Could it be that printing money out of thin air doesn't really create lasting wealth?

All the U.S. fans of quantitative easing should look across the pond at what is taking place in the UK. Its second round of QE was started last October. Yet, Britain has fallen into and remains in recession. It doesn't look like it will exit the recession by the end of the year either. So much for QE being a panacea for saving an economy.

The best case for the ineffectiveness of QE though comes from Japan. Japan has maintained a zero interest rate policy since 1999 (the U.S. had done so since 2008). After ten years of economic decline and malaise Japan began implementing quantitative easing in the early 2000s. The ten years that followed were also a period of economic decline and malaise. The Japanese stock market peaked in 1989 and over twenty years later it is still down more than 75% from its high (investors who fought the Bank of Japan are glad that they did). The various stimulus programs raised stock prices temporarily, but they eventually fell to lower lows.

The stimulus bag of tools that central banks use is meant to be effective when there is a cyclical downturn in the economy. However, they will not work if the problem is structural — and that is exactly what Japan has been dealing with since 1990 and Europe and America are dealing with today (and probably since 2000). We are at the end of the Keynesian era, where credit can no longer be extended to greater levels without creating a subsequent collapse and the economy can't grow without continual stimulus from the central banks and massive government deficits. This is sharply evident in the case of Greece and Spain at the moment, but it is just as true in the U.S., UK and Japan.

The Fed can't just cavalierly decide to engage in more QE as is. It will need to do so if there is a major financial incident in the EU and it can't waste its bullets. It is inevitable that there will be such a crisis, and the Fed knows it. Mario Draghi's assertion on Thursday that the ECB will do everything possible to save the euro was nothing but meaningless bravado. The crisis in Europe has been going on for over two years now and despite numerous bailouts and half a dozen support schemes it keeps getting worse. During the entire time, the powers that be in the EU have said that they will do everything to save the euro. Sometimes "everything" isn't enough. 

The Fed also has the problem of looking political if it acts before the election. While it is true that the Fed has acted before elections in the past, it actions weren't being closely scrutinized back then. Nor were its policies politically controversial. The House of Representatives just passed the Federal Reserve Transparency Act of 2012 by 327-98. This legislation would produce a full audit of the Fed. While it might not pass the Senate this time around, eventually it will.

While the Fed will almost certainly be doing quantitative easing again, but it won't happen until either  the problems in Europe become a full-fledge global credit crisis or the U.S. economy is in an obvious recession. In either case, it will not be something to cheer about. 

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 EU May Have Reached Its Bailout Limit

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, yields on Spanish 10-year sovereigns tested their yearly high yield of 7.28%, while Italian rates reached 6.16%. This was after funds for the Spanish bank bailout were approved by the EU, although the money won't be going directly to the banks. Earlier in the week, the IMF admitted that  the only solution to Europe's debt woes was to run the printing presses at full speed.

The situation in Spain is ugly and getting worse. Unemployment is almost 25% there and the country is in a recession. The Spanish economy is dependent on public spending and building empty houses that no one buys. The government has recently announced severe spending cuts and higher taxes, both of which will lower future growth. Yet, until today Spain was forecasting GDP growth of 0.2% for next year. It now thinks that GDP will decline by 0.5% in 2013. This is not just an optimistic scenario; it's a Harry Potter fantasy scenario. As is the case with Greece, Spanish economic and financial numbers cannot be trusted. Greece in the early stages of its bailout also produced optimistic projections of how easily and quickly everything would be fixed. Instead, its financial problems escalated out of control.  The same outcome should be expected in Spain.

Bailed-out Bankia is a good example of the how reliable the books are for Spanish banks. Bankia claimed to have earned a €300 million in profits in 2011, but in late May revised that to a €3 billion loss. Now Spain is in line for a €100 billion bailout from the EU, although it has claimed that it needs less. Based on how Bankia did its accounting, Spanish banks are likely to need more, maybe ten times more than that amount. This does not include money for bailing out the bankrupt Spanish government.  

Originally, the EU planned on providing the bank bailout money (structured as a long-term loan) directly  to Spain, who would in turn distribute it internally. When this caused Spain's sovereign debt rating to be downgraded, creating greater fiscal problems for the struggling government, the EU then decided to route the loan directly to the banks. Yesterday, the German parliament refused to go along. They were only willing to approve a loan directly to the Spain itself. It wasn't easy to get even that passed. Twenty-two members of Angela Merkel's coalition voted against it. The leader of the Free-Democrats described the bailout as "a bottomless pit". It doesn't look like German legislators have an appetite for any further bailouts and this is bad news for Spain and Italy as well.  

The IMF has an idea of what to do instead, but its solution could hardly be described as constructive. In a report issued on Wednesday, the organization essentially advised the EU to engage in every type of money printing possible, do a lot of it, and to start doing it immediately. The ECB has already expanded its balance sheet by more than the U.S. has and it hasn't solved the EU's problems so far. Massive money printing as suggested by the IMF would debase the euro significantly. So, in order to save the currency union, the currency it issues must be destroyed. Somehow, there seems to be a logic flaw in this line of reasoning (sort of like, a debt crisis can be solved by incurring more debt).

The bailout news today was disastrous for Spain and Italy. The Spanish IBEX index was down 5.79% dislocations  — a mini-crash and the worst drop in the two years. The Italian market was down 4.4%. The euro hit a new yearly low. The ETF FXE traded down to 120.78. This is below its bottom during the Credit Crisis, but still above the 2010 low made when the debt crisis first appeared. As the situation continues to unravel, more selling should be expected.


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.

Europe Continues Its Slide Toward the Precipice

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 Finnish finance minister has said all eurozone countries are making contingency plans in case the currency union breaks up. With debt downgrades, bond market anomalies, troubled bailouts, and austerity packages with their associated riots becoming the new EU norm, their worries are obviously justified.

Last night, Moody's downgraded Italy's government bond rating two notches from A3 to Baa2. This is just above junk status. Moreover, the outlook is negative with further downgrades possible in the near future.  So what happened in the Italian government bond auction this morning?  Did buyers  demand higher interest rates to buy Italy's increasingly risky debt as basic economic principles would predict? No they didn't. Italy sold €3.5 billion of three-year bonds at an average yield of 4.65%, much less than the 5.3% it had to pay last month.  How is this possible? Apparently Italian banks couldn't resist an urge to grossly overpay for their governments newly issued debt. The ECB was most certainly backing them up behind the scenes. If this is how Italian banks do business, can we assume that they're solvent?

There is little need to pose that question for Spanish banks. Recent data indicate that they borrowed €365 billion in June from the ECB — a record amount. This compares to €325billion in May. These numbers indicate that Spanish banks have been closed out of the interbank lending market (a good indication of insolvency). The highly troubled Spanish banking sector, which has €3 trillion in debt on its books, will be receiving an immediate infusion of €30 billion in bailout funds from the EU and another €45 billion in November. This represents 2.5% of its total debt and that amount is supposed to fix the problem. The actual funds needed will be many times that. It is impossible to say exactly how much because the financial numbers for Spanish banks are not reliable.

Spain seems to be following Greece's descent into a self-reinforcing economic collapse. This week Prime Minister Rajoy announced further budget cuts of €65 billion over the next two years.  VAT was raised from 18% to 21%. Almost a quarter of the Spanish work force is unemployed, even worse than Greece's 22.5%. Spain though seems to be making a more serious effort at fiscal austerity than Greece. According to reports in the German daily Rheinische Post, the troika on its latest visit found that the Greek government failed to implement 210 of the 300 budget savings requirements it had agreed to in exchange for its bailout money.

While interest rates are pushing against unsustainable levels in Spain and Italy, they have gone to theoretically impossibly low levels in northern Europe. Negative interest rates first appeared in government debt in Denmark and the Netherlands last December. Then Germany paid negative rates on some of its short-term bonds starting in January. This week, France sold six-month Treasuries at a yield of -0.03% and two-year bonds at -0.001%. Below zero yields are a sign of severe market stress.

The euro this week has traded below 1.22 to the U.S. dollar, but is slightly higher today. Investors should watch the 1.20 level. If the euro breaks and stays below this area of support, it could drop to parity with the dollar. The major central banks would intervene to prevent this though, so the ride down wouldn't be smooth.

Stock markets reacted bullishly in late June and early July to the news of further bailouts in the EU. Most traders didn't ask where the money would come from, nor if the plans were even legally possible. They may not be. The German constitutional court will be ruling whether or not Angela Merkel's promises to participate in the ESM (European Stability Mechanism) can go forward.  Even if they rule favorably, there is little actual money committed to the ESM. More money printing (and the ECB has already done quite a bit) is the only option left to fund the various bailout schemes to save the euro. Of course, it's logically absurd that a fiat currency could be saved by producing excess amounts of it. The same is true for trying to solve a debt crisis by taking on more debt.  But hope reigns eternal in the land of euro make believe.

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.

Central Bank Action Supports Credit Crisis View

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 was another confirmation of an emerging credit crisis yesterday as central banks in various parts of the globe took coordinated action to pump money into the financial system. The banks involved though claimed it was mere coincidence that they all acted at the same time.

Central banks are generally only interested in dealing with their own internal matters. On ocassion though, they act together as they did in October 2008 at the height of the Credit Crisis. Massive stimulus from lower interest rates and quantitative easing finally allowed the markets to put in a bottom six months later.

On Thursday, the People's Bank of China cut its key lending rate by 31 basis points (a basis point in one-hundredth of a percent) to 6%. This was a previous cut less than a month ago. Manufacturing has been declining for months now in China and there are some estimates that GDP will barely be above 7% this quarter. While this would be enviable for any North American or European economy, below 7% growth would feel recessionary in China. Lowering interest rates is not without risk for China since the country also has a massive real estate bubble and this will continue to feed it. 

At the same time that China was cutting rates, the ECB cut its refinancing rate to 0.75% from 1.00%. The banks' deposit rate however was lowered to zero (obviously not much room to maneuver left there). While the ECB has still not fully implemented ZIRP (zero interest rate policy), which Japan and the United States have now maintained for years, it is so close that the difference is irrelevant for all practical purposes.  The Bank of England did not lower its 0.50% benchmark rate, but instead raised the ceiling on its current round of quantitative easing by 50 billion pounds. They've obviously come to the conclusion that once rates have gotten close to zero, money printing is the only way to go.

Absent in any obvious way from yesterday's action was the U.S. Federal Reserve. It already had its monthly meeting at the end of June and announced an extension of Operation Twist (an attempt to drive 10-year yields lower even though they had already hit all-time lows on June 1st). The market bulls were claiming that the Fed would announce a third round of quantitative easing, but they didn't. The Fed is also going to have trouble engaging in more QE in the near future because the U.S. is once again near its debt limit. National debt is now over $15.8 trillion and the debt ceiling is $16.4 trillion. The two will come together at some point this fall. To implement quantitative easing, the Fed has to buy newly issued treasuries. When the debt ceiling is reached, there won't be any. It took months to raise the debt ceiling last time and it is likely to be just as contentious an issue this time as well.

The current global financial crisis is centered in Europe and nothing has been fixed there. The EU has been trying to keep 10-year bond yields below the critical 6% level in Spain and Italy since last summer. They have utterly failed in the case of Spain. Spanish 10-year governments were over 7% in June (higher than last fall, which was in turn higher than last summer). After being driven down close to 6% twice in the last two weeks, the yield was as high as 7.04% today. Italian 10-years traded at 6.08%. Rates continually above 6% mean that Spain and Italy will need bailouts, but the necessary money will have to be printed. Germany holds the keys to the printing press however and may not let them be used.

Stock markets worldwide have held up remarkably well considering there are serious problems in the financial system and the global economy is weak. Liquidity from central banks is responsible for this. However markets have a tendency to revert to realistic prices and if they aren't allowed to do that gradually, they will do so suddenly.

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.