Thursday, October 31, 2013

Halloween, is it a joke, or something really sinister? 

FOMC

The Federal Open Market Committee (FOMC) announced its stance yesterday.  Everyone of you know that QE infinity is still on, and there will be no tapering in the near term.

Here is what FOMC said:

"When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%."

The interpretation by traders world wide?  As soon as the labor market improves, the USA will taper bond purchases.

Overall, the stock market exhibited its extreme rise in volatility, before settling back into some level of normalcy.  There was no rout, and even though the market settled lower, it was lower pretty much from the opening of the NYSE.  Unless you watch the market all day long, you would never know that the announcement caused an up move, a fairly large down-move off the high of that up move, and then a recovery to almost where the price was when the FOMC announced they were continuing to continue. 

From my perspective - the stock market found it a non-event, and the same for Gold and bonds.  (Yes Gold went down slightly, dollar went up slightly.  Bonds and notes went down, which suggests that investors world wide believe QE will keep the interest rates lower.)

Richard Koo, the Chief US economist for Nomura Securities believes FOMC is in a vicious cycle he calls the QE trap.  http://www.businessinsider.com/koo-says-no-one-can-refute-the-qe-trap-2013-10 

I've not read Mr. Koo or studied his work over time, but he has a very good point.  I've written about this previously in my newsletter, but Mr. Koo presents some very compelling graphics to support his point.

I can summarize his article as follows:

• ·         Initially, long-term interest rates fall much more than they would in a country without such a policy, which means the subsequent economic recovery comes sooner.
• ·         But as the economy picks up, long-term rates rise sharply as local bond market participants fear the central bank will have to mop up all the excess reserves by unloading its holdings of long-term bonds.
• ·         Demand then falls in interest-rate-sensitive sectors such as automobiles and housing, causing the economy to slow and forcing the central bank to relax its policy stance.
• ·         The economy heads towards recovery again, but as market participants refocus on the possibility of the central bank absorbing excess reserves, long-term rates surge in a repetitive cycle I have dubbed the QE "trap."

 Here are the facts, however.  Mr. Bernanke introduced "tapering" in June, and that bit of lip flapping caused a huge drop in the stock market.  Interest rates rose in the mortgage market to a level that threatened the housing recovery.  (By the way, the housing recovery seems to be dead.  This may have been predictable as it was not the common person driving the market.  It was the big investment houses that were driving the price up.  Arguably, there are places in the US where the demand for housing by people was high.  These were in areas where companies need employees as Oil and Gas production soared. ) Then it was thought that the Fed would taper in September, and stock market went down.  After the did not, the stock market skyrocketed higher. 

It would seem even lip flapping by the Fed will cause painful correction, and heaven help the markets when and if they taper.   If they ever really taper, then there will likely be a "crash" in all consumer goods, which in turn causes a down turn in nearly every interest-rate-sensitive sector - consumer goods basically.  In turn, the Feds will relax tapering again, and the economy will recover until the next round of tapering.

From an outsider's perspective, the Fed is trapped in exactly the same position as Japan was 20 years ago.  Japan 20 years ago, started a program to stimulate the economy.  After 10 years, they were stagnant, and young people could not get jobs to fulfill the need.  Then Abenomics have taken effect, and Japan went all out to devalue their currency, increase their exports and bring prosperity for all back into Japan.  So far, it appears if we look at all is that the current levels of QE in Japan are ineffective, but the long term costs to the people are going to be devastating.  Last night the Japan Labor Ministry reported.

If we (in great empathy I hope) look at the success of Abenomics on the general improvement in living conditions measured by the only metric that matters - wages - then Abenomics is a disaster.  The nation's salaries extended their slide marking the 16th straight month of decline.

Dear readers, if we consider what I've posted from Mr. Obama's comments on the middleclass decline, you will know that QE in Japan has not worked for the wage earners.  The key for Abenomics success is companies raising wages and employing more people.  It has not happened in Japan, and it will likely not happen here.  http://mobile.bloomberg.com/news/2013-10-31/japan-salaries-extend-fall-as-abe-urges-companies-to-raise-wages.html

Once leadership of a country goes down the QE path, then changing direction will be far more difficult (it appears) than it was to start the program.  Why was QE even attempted?  Due to the issue no 3 experts in economics or finance agree, may I suggest that QE was tried and supported because Greenspan was successful in managing what in hindsight appear to be minor recessions using monetary policy.  Stimulation via of easy money seemed to work. 

Did Greenspan's policy cause bubbles?  Irrespective of what criticism are leveled his way, his policy alone did not cause Bubbles.  The housing bubble had to be caused first by a policy change (and looking the other way on banking regulations) at the President George W. Bush level.  Then Greenspan had to provide the liquidity, and the banking regulations had to be set aside.  Banks then had to invest in ways that were never observed in history (not just in the USA, but in the whole global economy - particularly Europe).  The global financial catastrophe was not the result of one evil (or mistake prone) man.  It was not one company. 

What did cause all the pain and suffering (which China does not seem to be experiencing) globally?  A system of globalized finance, interconnected credit markets and over leveraged economies.  All this was inherently unstable.  If one was to read and reread Taleb's Black Swan, then we would very likely conclude that any baby economic event would turn into a disaterous "Black Swan" event - where "The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology"  Nassim Nicholas Taleb 

Until one realizes in hindsight that the global financial systems were unstable.  Until this toxic mix of everything related to everything else that was highly leveraged through super derivatives was developed and enabled by technology, a sub-prime housing market in the USA would not have caused a melt-down in the global marketplace.  And one dark night it happened...  A bank in France said they could not price the value of the assets in the credit swaps. 

That was more like Gladwell's Tipping Point, as most bankers already were extremely worried over the debt that the world had created in a very short time period.  This was the little event that starts a Black Swan event.  On March 5, 2007 HSBC, Europe's largest bank says the US subprime market is unstable and the effect is on HSBC's company earnings.  Within a few days New Century Financial Corp, which specializes in lending to people with poor credit files for bankruptcy after a mass event of customer defaults.  The little bank in France that called "the emperor" has no clothes, is lost now in time.  It is too bad, because in many ways the analysts who were bold enough to point this out should be considered heroes, but if their names were known, they would probably be lynched. 

Since the current (and persistent) USA and Global predicament is the normal business cycle downturn, the current stimulus program has reached the end of the road. 

In order to get short-term interest rates low, the Fed has flooeded the banking system to the point that short-term rates are essentially zero.  However, this liquidity flood is not funding new bank lending. 

If you wonder why, then ask yourself what is the wage earner doing out there?   In general, the job market is not employing, even if the BLS (Bureau of Labor Statistics) says unemployment is going down.  Foodstamp enrollment has grown substantially.  Basically at the wage earner level (more than 80% of the people in the USA) has deleveraged through either paying off loans, or defaulting. 

In turn, the wage earner has cut back in spending as well.  This greatly worsened the economic crises of 2008. 

Then as one expects in supply side, the supply of goods must decrease as no one buys.  That leads to companies large and small to not borrow either.  Many public companies are sitting on piles of cash and excess production capacity -- supply and demand.

As I observe all this, I can't help but think the excesses of the US government over the last 80 years is coming home to roost.  We, the People, are going to have to pay the debts or default.  Of course, the argument goes that the USA can inflate the debt away, but that is not working out so well for Japan is it?

QE either ends up as excess bank reserves or seeps into the financial markets.  Neither event is likely to be effective in the economy gaining momentum that is self sustainable. 

In hindsight, dropping money from a Helicopter would have been much more likely to stimulate demand which in turn would have stimulated production.  

How to unwind?  It will be painful for the people.  The rich in the Presidency, FOMC, Congress and Senate do not get it.  Giving money to the rich does not stimulate the economy.  They (all of them) have devastated the middle-class and the poor wage earners.  Those classes of earners are not coming back anytime soon. 

It will not be pretty, but we must figure a way to unwind the Federal Reserve Tapering, and at the same time figure out how to pay off the debt. 

And if you think this will be easy, then turn to studying city government.  Detroit is not the only city with major league problems.  Just a little turn up in the interest rate, and the cities of this nation are going bankrupt - not just a few; many many many of them.