Around the Globe 10.28.2013

Pending Home Sales Show Sharp Drop – WSJ.com.

Pending Sales of Existing Homes Slump by Most in Three Years – Bloomberg.

Pending home sales drop 5.6 percent in September.

U.S. pending home sales fall by most in more than three years in September | Reuters.

NAR Pennding Home Index through 09.2013

The MFP is rightly attributing this fall in pending home sales to the precipitous rise in mortgage rates since May, though the NAR would have you believe that the shutdown beginning on October 1 somehow affected pending sales from September.  Houses have become dramatically more unaffordable since May from rising rates and housing prices against the backdrop of stagnant incomes.  The only way for the housing market to improve at this juncture would be from gains in consumer income, which is not in the cars.

 

Hilsenrath to Wall Street: You don’t know Fed.

QE Infinity? No end in sight for money printing.

In Fed and Out, Many Now Think Inflation Helps – NYTimes.com.

Fed Balance Sheet vs. SP500 Last Year

If you wish to know the Fed’s future money printing output, this is the only chart you need to understand.  The Fed buys bonds, and the sellers invest those proceeds into stocks raising prices.  When the Fed stops or even threatens to stop, the whole trade begins unraveling. While the Fed claims to be concerned with unemployment and inflation, the Fed is extremely apprehensive about the consequences of a falling stock market.    Going forward, the Fed will continue to use low inflation and poor labor market data to justify continued printing to support both the government bond and stock markets.

Analysis: Convalescent euro zone seeks to escape debt overhang | Reuters.

Currency Woes Batter Europe’s Industrial Giants – WSJ.com.

EURUSD 10.28.2013

From Yahoo Finance

The Eurozone and the MFP is really counting on PIIGS exports continuing their rise in order to support the Eurocrisis Recovery Narrative.  Unfortunately, a rising euro will stop the export “boom” in its tracks.  The Euro will continue to rise as the Fed continues to print.  Moreover, Eurozone banks are still selling overseas assets to bolster capital ratios back home.  This process has created  background buying pressure on the euro that may even pick up as these backs clean up their balance sheets in advance of the commencement of the “banking union” in late 2014.

Not happy at work? Wait until you’re 50 or older….

This article is typical of the drivel spewing from the mouth of the MSM.  People report increasing job satisfaction after 50 because of some rather obvious selection bias.  People switch jobs several times over the course of their careers.  If your job sucks, you quit it in the hopes that the next job will be better.  This process will continue until you find a job that you enjoy.  Then, you will stay with it as long as you can.  It is not surprising that people settle into a comfort zone with their employment when they reach the last stages of their careers.  So the article’s advice to sit around and “just wait” until you’re 50 is poor advice.  It takes a lot of work to obtain satisfying work, so get to work already!

Around the Globe 06.04.2013

An Austerity Success Story in Slovenia – Bloomberg.

Slovenia GDP Performance through 2013

Slovenia Debt to GDP

The article is entitled, “An Austerity Success Story in Slovenia.”  Examine the charts above and tell me where we may find the success.  GDP is cratering amidst skyrocketing government debt and unemployment and will continue to do so as long as Slovenia is shackled to the uncompetitive euro.

The only cure for the Euroflu is strong, sustained economic growth.  Since a painful internal devaluation will not be sufficient to stoke growth, the quickest way for Slovenia to return to health is for it to revert to its old national currency.  That would be success.  Anything else is just talk.

Gross Says Reduce Risk Assets Since QE Not Boosting Growth – Bloomberg.

Pimco’s Gross Skewers Bernanke: You’re Part of the Problem.

Fed Balance Sheet Projection 2014

I concur with Mr. Gross that the Fed is the problem here, but allow me to add a reason to his list.  Cheap money is allowing those who made bad investment decisions to stay in the game rather than liquidating.  Hence, unproductive assets are not changing hands.

Liquidation is a natural part of the creative destruction process.  When an investor can no longer finance a bad decision, he liquidates, and someone who wishes to put the asset to productive use gets it at a bargain.

For example, Mr. Red buys an office building but is unable to charge enough rent to cover financing, so he sells it at a loss.  Mr. Blue buys the building on the cheap and invests money in it to refurbish it and hire a maintenance staff.  In this scenario, economic growth is happening.

What the Fed has done is lower Mr. Red’s financing costs so that he does not have to sell to another investor who may extract more benefits from the assets adding to the country’s GDP.  Stagnation is the price we pay for inflated asset prices.

Stock Gains ‘Well Supported’ by U.S. Earnings: Chart of the Day – Bloomberg.

SPX to US Corporate Profits

The mainstream media really wants you to buy stocks.  A cursory inspection reveals that stocks appear historically cheap when compared to other eras, but one key piece of information is missing.  Interest rates are much lower today than they were in 2008.  As such, the index to profit ratio for 1Q2013, or the return, much be discounted with this in mind.

Rates (US 10 yr note) are roughly half what they were in 2008.  Adjusting for interest rates, we double today’s ratio to $2bn.   As the chart above reveals, the stock market is once again at bubblicious, historical highs courtesy of Uncle Ben and his magic money machine.

Europe’s Black Market Economy Is Booming.

Greek Government Revenues

Tax increases never work as planned due to the black market.  Higher tax rates force economic activity underground.  Greece has increased rates and created brand new taxes since 2010 in an attempt to raise extra revenue to deal with its debt crisis.  As the chart above indicates, tax collections have actually fallen in response.

What high taxes do is make economic activity at the margins unprofitable.  This dynamic forces participants to make a choice.  They can either cease the activity or move it to the black market where it remains profitable.  Fortunately for Europe, those people are choosing the black market so they can continue to feed, house and clothe their families.

Reckoning Nears for Detroit – WSJ.com.

Detroit Population

Detroit problem is simple to identify.  In 1950, the city was home to almost 2 million people, but now its population is a little over 700,000.  A small city is supporting the infrastructure and legacy costs of a much large one.

Cities become depopulated all the time as one learns from visiting ruins scattered throughout Europe.  In ancient times, there were no civil servant pensions to worry about.  Since Detroit cannot afford to pay all of its legacy costs, it won’t.  Bondholders and pensioners will lose money from the inevitable Detroit bankruptcy no matter what laws are on the books.

Fed Endgame

Courtesy of ZeroHedge

Courtesy of ZeroHedge

Here’s How the Fed May Finally Lose Its Power.

Money is supposed to be a store of value in part due to its scarcity. When a government can create an infinite supply of money at will, it is no longer valuable. There are numerous examples in history of a country deciding to print as much money as it needs; none have ended well.

In late 2008, ongoing deleveraging in the financial sector finally led to a panic. Rather than allowing the panic to destroy the weak firms, the world’s central banks decided to support the entire financial system, good and bad, by printing unprecedented quantities of money.

Once large-scale monetary intervention begins, it cannot stop. Ceasing money printing will allow the financial panic to restart and run its course. Whoever is in office at the time of the panic will be blamed and have a more difficult path to reelection; hence, there is great political pressure on the Fed to deliver economic growth or at least its perception by money printing.

Additionally, central bankers have decades of intellectual capital built up in Keynesian models. These models tell them that creating enough money will eventually lead to sustained growth. If money printing is not working, then the answer is more money printing, not a different course of action. The Fed Chairman is the high priest of a cult, and high priests can never admit that they are wrong.

While the economy, measured by the workforce’s job prospects, is not improving, at least it is not getting worse. The reason for this is that the world is enabling the Federal Reserve’s bad behavior.

There are two ways that the Fed’s intervention is supposed to spur economic growth. First, lower interest rates should lead to more business loans and more business activity. Second, printing more dollars increases their supply while demand remains the same lowering the exchange rate. A cheaper dollar should lead to more exports.

Our trading partners do not wish to lose business to a cheaper dollar. While they cannot affect the supply of the dollar, they can certainly raise demand, and they accomplish this by purchasing dollars and investing them in U.S. treasuries.

The largest currency manipulators are Japan, Taiwan, Switzerland, Hong Kong and China. Only China has reduced its U.S. treasury holdings in the last year. The rest of the countries have increased theirs in order prevent their currencies from rising against the dollar.

While the article discusses the end of the Fed’s power, this system has survived for years and shows no danger of failing any time soon. All of the world’s central banks are soaking up dollars and preventing them from reaching markets where they could do a great deal of mischief .

This can go on forever, or it can stop tomorrow. We entered experimental territory in late 2008 and have not looked back, and the system remains in a state of equilibrium. All the dollars (and euros, yen, sterling…) printed prevent the system from crashing, but they also seem the prevent it from healing. The economy may not improve, but at least it is not getting worse.

There are two types of Fed watchers. There are the fedophiles, who believe that central bank action can solve any problem, as long it is performed on  a sufficient scale. The other group are the contrarians, who point to examples of hyperinflation caused by debt monetization in Zimbabwe or Weimar Germany.

My greatest fear is not hyperinflation. Rather, it is that we wind up like Japan caught in perpetual stagnation caused by central bank action. With a crash, we would realize the error of our ways and construct a new, more resilient financial system. Stagnation can endure for decades with no action being taken, because things are not getting worse until they do all at once.  At that point, it is too late for reform.

One Central Bank Head Departs Groupthink

Hong Kong Monetary Authority Chief Executive Norman Chan speaking at a conference last year.

Hong Kong Fed’s Epiphany: Is Bernanke Wrong About Everything? | ZeroHedge.

Norman Chan, head of the Hong Kong Central Bank, diverges from the mainstream regarding the Western central bank’s ongoing printapalooza. He believes that the process of deleveraging occurring in the wake of the GFC could be disrupted by quantitative easing, and as a result asset prices could fall off a cliff and remain volatile.

In his estimation, overborrowing is what caused the GFC and the current eurocrisis. It is interesting that he differentiates the two. In my opinion, the eurocrisis is merely an extension of the GFC. All this euro-trouble started in 2009 and has continued ever since.

Mr. Chan believes that

The disruption in the deleveraging process is leading to asset price increases that are unwarranted by the fundamentals. In that case, households are unwilling to increase spending and the economy will remain stagnant.

This is an interesting hypothesis. Basically, he is saying that people are not stupid. They regard the price increase in assets such as homes and 401k’s as illusory. Since they do not recognize these gains, there is no increased consumption from a so-called wealth effect.

Furthermore,  averring that markets will crash because deleveraging has been disrupted implies that deleveraging is a natural process that needs to occur in the wake of a financial crisis. Market crashes are self-fulfilling deleveraging events as margin calls force investors to sell assets to pay debts.

I agree with Mr. Chan. The consequence of this line of thinking is that Since the deleveraging must eventually occur, all of this money printing is merely forestalling the inevitable. Each round of easing is doing less. Various ZeroHedge charts show the diminishing returns of each successive round of central bank action.

This chart published today illustrates that for the first time markets failed to bounce on the day of the Fed’s easing announcement:

Another chart from earlier in the day details that the Fed is becoming desperate to hold up asset prices with easing becoming more frequent. The time between the announcements of unsterilized, meaning expansionary, interventions has declined in four steps from almost 600 days to less than 100:

It is apparent in this chart that each successive round does less and less. Intriguingly, Fibonacci may recognize the pattern, which roughly follows the golden ratio Φ.

There is a stimulative effect on the economy from these interventions, but they have been fading, too:

We are quickly approaching a turning point. One of these rounds will fail to stimulate markets. When that event occurs, it will portend the next crash. The deleveraging that should have take place since 2008 in addition to other imbalances built up within the system since then will be thrust upon the system in a disorderly fashion. The beginning of the GFC pale in comparison to its end.

Nobel Laureate Ignores the Cantillon Effect

Seminal economist Richard Cantillon

Seminal economist Richard Cantillon

Robots and Robber Barons – NYTimes.com.

Krugman does not understand how large entities can be making record profits at the same time that individual workers are doing poorly. Monetary easing from the world’s central banks should be stimulating demand and raising wages, but it is not.

He gives two reasons why his prescription of easy money through central bank printing and government spending is not curing the patient— robots and robber barons. Robots are replacing people, while robber barons through their corporate monopolies are able to extract higher profits due to a lack of competition.

In the first case, robots add to productivity, which increases economic growth. Someone creates, manufactures, installs, maintains and uses the robot. Most of the high-value work is done right here in the good old U.S. of A.  Then, the robot is producing something, which needs to be sold, shipped and financed by American workers. Just like the cotton gin raised productivity and income for both workers and owners, I have a feeling our humble robot is doing likewise.

In the second case, he does not give an example of a monopoly but does cite a study where two economists say increasing business concentration could be an important factor in decreasing prices for labor. This statement is unpersuasive. Can you think of any industry that has monopoly pricing power?

Think of a company, and you will be able to conjure several competitors. You give me Apple, I respond with Samsung and Google. General Motors contends with Ford and Chrysler just in its home state let alone the Japanese and German competition. Even Time Warner Cable competes with two satellite companies and Verizon FIOS in my neighborhood.

One economic theory explains how large entities can succeed while individuals struggle, the Cantillon effect. An early economist writing during the Enlightenment and a contemporary of Voltaire, Richard Cantillon theorized that easy money helps those closest to it. The effects of increased demand decrease the further one is from the source, in 21st Century America, the Fed.

This theory explains the current economic situation. Easy money from the Fed is feeding the good times enjoyed by the TBTF banks, who receive the money first, and then their rich corporate and private clients. The banks are making record profits, the other corporations are doing just as well, and their leaders, the 1%, are also making out like bandits.

Meanwhile, the middle and working classes are being hammered. While their wages stagnate, central bank cash ensures that there is no price relief through deflation.

Mainstream economists have expended enormous intellectual and academic capital on massive central bank intervention creating economic growth proposed by Keynes over 70 years ago.  Hence, just like 18th Century doctors practicing bloodletting, they cannot see that their proposed cure is actually causing the disease.

The Fed has no Exit Plan

Fed Exit Plan May Be Redrawn as Assets Near $3 Trillion – Bloomberg.

There is a fiction circulating among academic and journalistic circles about the Fed’s exit plan from its multitrillion dollar bond purchasing programs. The fiction is that the Fed will be able to cease and reverse this policy some day when normal growth returns.

In 2008, the Great Financial Crisis began to force all types of markets downwards. You could point your finger at several different precipitating events, but the crisis was caused by too much debt accumulating in the financial system. In response to these high debt levels, people and companies began deleveraging, which really means getting rid of the debt by various means including paying it off or defaulting.

Deleveraging has been considered bad as it was blamed for the Great Depression rather than being a coexisting symptom with high unemployment and sinking GDP of too much debt in the system. Bernanke and the most central bankers believe that had monetary policy been massively eased during the 30’s, the Great Depression would have never occurred.

However, monetary policy was eased in the 30’s. The country left the gold standard resulting in a 35% devaluation of the dollar, and the country ran budget deficits. To cope with another episode of too much debt, easing is being attempted  to deal with Japan’s economic stagnation that has lasted twenty years or so. Now, the U.S. and and Europe have joined the easing club.

If you point out that easing has been and is being attempted to no avail in these situations, he will tell you that the problem in each case is that there is not enough easing.

Monetary easing is more of a religion than economic doctrine, because the level of proof required to show the believers that it does not have the desired effect does not exist.

In following the religion of the monetary easing, the American high priest of the religion, Ben Bernanke, has created replaced the debt leaving the system through private deleveraging with government leveraging, that is debt purchases. Additionally, the federal government itself has picked up the slack by adding more debt to the system by running larger budget deficits.

The Fed’s bond purchases have bid up the price of bonds over the last few years throwing the entire risk structure out of whack creating a second real estate bubble, a stock market bubble and bubbles in the art market and even collectible cars. Wherever you look, there is another bubble.

The secret about the exit strategy is that there really isn’t one. Once intervention starts, it cannot be stopped. Since the onset of the GFC, cessation in Fed bond buying has led directly to stock market tumbles. In response, the Fed must announce another program to buy bonds and keep markets buoyant:

Each round of intervention does less. Eventually, a round in the future won’t move markets at all. This will be the signal that the Fed and central banks around the world are powerless, and the endgame will commence.