Why Quantitative Easing Will Raise Long-Term 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 two-year treasury yield fell to another record low on Monday, touching 0.3987%. The 10-year treasury yield was up slightly however in September, rising for the first time since March. Federal Reserve money-printing is behind both falling shorter-term rates and rising longer-term rates.

A survey by Bloomberg of more than 60 mainstream economists indicates they expect 10-year treasury yields to keep rising in 2010 and through 2011. Perhaps someone has been passing around some notes on the approximately 500 hundred year old 'quantity theory of money', which states if the amount of currency is increased without an appropriate increase in economic growth, inflation will result (and consequently interest rates will have to rise, with the biggest increase taking place on long-term bonds).  For this not to happen, the laws of simple arithmetic have to be violated. The Federal Reserve has essentially been maintaining that that is what has taken place for the last two years. Bernanke of course does not directly state that we have entered a new economic age where two plus two no longer equals four because he would be laughed out of Washington and even the never questioning U.S. mainstream media wouldn't print such garbage.

Bloomberg also reports that a survey of primary dealers (the people who buy the paper that the Treasury issues) estimates that the Fed will buy $100 billion to $1 trillion in Treasuries by the end of the year. According to Deutsche Bank however, the market has reacted as if $315 billion to $670 billion of quantitative easing has taken place recently. The Fed announced on August 10th that it would be conducting further quantitative easing this year. The stock market then had its best September in seven decades. Money printing is an easy way to juice up stock prices. And since there is an important election on November 2nd, it would make sense to think all or almost all of what is scheduled for 2010 will take place before people vote. It looks like that is exactly what is happening.

While the Fed's actions can make the stock market look good in the short-term (investors need to watch out for what follows however) and can make shorter-term rates like the two-year go down because of all of the buying that it is doing,  longer-term rates will go up if the market sees this as inflationary. The 10-year treasury is the bench mark for everything from home mortgages, to credit cards, to corporate bonds. Higher yields on the 10-year are a drag on the economy. The Fed has supposedly reinstituted quantitative easing to stimulate the economy, although there is little evidence that the Fed has managed to stimulate the economy very much in the last three years. The stimulus has instead come from massive government budget deficits. The Fed seems oblivious to the existence of a liquidity trap, a condition where increased 'money' generated from the central bank just moves around the financial system and never gets into the real economy. Under such circumstances, doing more of the same won't make things any better, but can easily make them worse.

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.

Q2 GDP Up Only 0.7% Without Government Spending

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 Bureau of Economic Analysis revised second quarter GPD growth down from 2.4% to 1.6% today. Stimulus spending peaked in the second quarter and despite the big boost that it provided, the U.S. economy only expanded at a rate that indicates the U.S. standard of living isn't declining further.

The U.S. needs GDP growth (adjusted for inflation) at about 1.5% for the well-being of the average person to remain the same. This is because of population increases and other factors including some overstatement of the numbers. Actual growth, meaning more jobs and increased incomes for the American people, only takes place when the GDP number is above that level. The U.S. right now needs a substantial amount of actual growth just to make up for the decline from the Credit Crisis/Great Recession and to get back over eight million lost jobs. Despite $2.7 trillion in federal deficit spending in the last two years, it's just not happening.

At the bottom of the Credit Crisis/Great Recession GDP declined at a 6.8% annual rate. So far during the 'recovery' GDP growth has been:

2009 Q3  1.6%
2009 Q4  5.0%
2010 Q1  3.7%
2010 Q2  1.6%

Most of this has come from changes in inventories -in the first three quarters, approximately two-thirds of 'growth' came from this one factor. Indeed this also would have been true of the Q2 number as well if the inventory component hadn't been lowered. Inventories for Q2 were originally reported as being responsible for GDP growth of 1.05% (divided by the new 1.6% total, this would indicate inventories were 66% of Q2 GDP growth). However the inventory contribution to GDP was revised downward even though according to the BEA, "Private businesses increased inventories $63.2 billion in the second quarter, following an increase of $44.1 billion in the first quarter". The smaller increase in inventories in Q1 was responsible for GDP increasing by 2.64%. This is a peculiarity of GDP math. In 2009 Q4 inventories decreased (yes, decreased) by $36.7 billion and this created 2.83% GDP growth. A decrease in inventories also created a 1.10% increase in GDP in Q3 2009.

Government spending was supposedly responsible for 0.86% of GDP growth last quarter. Subtracting that from 1.6% leaves only a 0.74% increase in Q2 GDP. Describing this as anemic would be an understatement. The federal government however accounts for almost a quarter of the U.S. economy and its spending increased by 9.1% in Q2. This would seem to indicate that the federal government contributed a lot more to Q2 GDP growth than what the BEA claims. It also begs the question as to how good the GDP numbers will be when government spending significantly declines as it is scheduled to do in fiscal 2011.

Q2 GDP would also have also been a lot lower without big increases in 'Gross Private Domestic Investment', which was up a whopping 25%. 'Equipment and Software' was up by 24.9% between April and June. In the recently released durable goods report for July, it had a big drop, as did machinery and other components in this category.  Two years of stimulus spending is responsible for revving up the investment component of GDP in the second quarter, but economic reports from early in the third quarter indicate that its impact is already waning. We will have to wait though until just before the November election to see the first numbers for Q3 GDP.

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.

Some Recovery, Half a Million More Unemployed Last Week

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.


After more than a year of economic 'recovery', the Department of Labor reported weekly unemployment claims rose to 500,000 last week. Any number at 400,000 or higher indicates recession. The last time weekly claims were below that number was the week of July 17, 2007 - more than three years ago.

The unemployment problem has two components - not enough hiring in the private sector and too many job losses for people who have jobs. The lack of hiring can be seen in the monthly non-farm payrolls report and the too much firing shows up in the weekly unemployment claims. Not all U.S. workers are eligible to collect unemployment however so the weekly claims numbers understate the actual number of people who lost their job. Even with the understatement, unemployment looks bad enough as is.

The number of former workers collecting extended benefits rose to 4,753,456 in the week ending July 31st (the most recent data). This was up 260,105 or over 5% from the previous week. A year earlier in 2009, only 2,961,457 were in this category, which includes people unemployed for over 26 weeks. So the number of people who are long-term unemployed and have not yet exhausted their benefits has risen over 60% in the last year -a year when economic recovery was supposedly taking place.

Since November 2009, the weekly jobless claims have mostly been in the 450,000 to 500,000 range. There is no noticeable trend of improvement. This is amazing, not just because of trillions in deficit spending that the government told us would make the economy better, but over the long-term (and three years is the long-term) this number should automatically drift down. Companies have to have a certain minimal amount of employees to run their operations. As time goes on, the number of people that can be terminated drops significantly and so should weekly unemployment claims. This drop in claims wouldn't mean the economy is getting better, although the mainstream media would blast headlines claiming that was happening, it would mean that there aren't a lot of people left to fire. At this point in the cycle, since claims aren't dropping, business activity has to be continually declining to maintain the same high unemployment numbers. That's the definition of a recession, not a recovery.

Investors should not be surprised if the weekly unemployment claims numbers start looking better soon and for the next couple of months. The U.S. employment situation is a major embarassment for the administation and there is an important election in November. This week, the president is making appearances in  five states to make the case that it was worth borrowing trillions of dollars for stimulus spending and doing so has put America 'back on the road to recovery'. The last nine months of weekly unemployment claims certainly aren't supporting this view. With a statistical adjustment here and there though, the numbers could suddenly look a whole lot better, even if the economy isn't improving at all.

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.