Economic Condition Review

Here at the end of the 3Q2011 all eyes are focused on the European Union (EU), the European Central Bank (ECB), the International Monetary Fund (IMF), the Federal Reserve Bank (FRB), and now laser like focus on the 17 European Monetary Union (EMU) parliaments who are individually considering their agreement to further assistance for Greece. The process is complicated by the complexity of the euro currency experiment. It is also complicated by the number of politicians in positions of influence. I hope cynicism is reaching high tide. The danger is extreme if there is not a plan developed to corral the ripple effects from what is expected to be substantial losses to major banks who are Greece's sovereign debt owners. One danger is that there is a known lack of adequate reserve capital at several European banks due to their investment in the sovereign debt of Greece and other over indebted countries. Compounding the problem is the lack of detailed information about credit default swaps intended to hedge risk on Greek debt. Lack of information deepens the fear.

The probability of Greece's default is high as reflected in the yields for their debt. Greek 2 year bonds yield 65.24% and their 10 year debt costs them 22.67% as of 9/29/2011. For reference, 10 year bond yields in other EMU countries are Germany at 2.01%, Italy at 5.58% and Portugal at 11.16%. The US Treasury 10 year is at 2.00%. The problem is how to contain the eventual wreck.

Economic Condition Review: August 2011

Looking back since my last review in June the world has recovered from the tsunami and earthquake damage in northern Japan (Japan is still in recovery/clean up mode), the civil revolt and dictator overthrow in Egypt has resulted in a power vacuum which will be resolved by election later, the dictator of Libya, Muammar Gadhafi, has been defeated by his opposition according to news reports. Other uprisings are beginning to build in several other oil producing countries in the region, including Syria and Persian Gulf states. The threat of crude oil shipments being interrupted is a growing concern for all countries importing from this region. Despite these pressures, the price of Brent Oil has softened recently from more the $120 to now $108.62.

In Europe, the socialist government of Portugal has collapsed and is now moving on with a new center-right government. The government of Greece has had to renegotiate the bailout terms with the ECB (Germany and France) as a condition of getting the last installment of their bailout package. The renegotiated plan now calls for Greece to liquidate much of its net worth (state owned assets like airports and transportation services) as well as agree to new austerity. Can it get any more dire in Greece? Misery likes company and Italy, the eighth largest economy in the world, is drawing attention to itself for having public debt at 120% of GDP. That's second, to Greece, in the euro zone. Spain is on the radar screen now as well.

China is still wrestling with internal high food and shelter inflation threatening the massive lower classes, potentially destabilizing the power of the ruling party. Published reports describe interest rate increases are the tool to fight inflation in China, to slow lending for business and personal discretionary consumption.

In the US, the Treasury market is finding some strength on a risk-off move. The yield on the 90 day Bill is 0.00%, the 2 yr T-note is 0.19% and the 10 yr T-bond is 2.06%! The US$ is weak, trending between 73.50 and 76.00 during the past several months, and currently near the 74 mark. 'Risk off' has been a reaction to the US Congress displaying their lack of ability, building the case daily until the beginning of August when they finally extended the US public debt limit. The public display of incompetency was so much greater than expected that some economic activity slowed as a result of the spectacle and resulting loss of confidence in the leadership ability of the US government.

Calculated Risk has a summary of the recent economic reports which illustrate that the economy is not growing, but is not collapsing into recession. New home building is slow and existing home inventory is still large. Industrial production is  trending sideways or improving. Same trend for production capacity utilization.

The Federal Reserve is pulling the strings to guide global perception about the strength of the US$. The Fed has no choice but to continue it's zero interest rate policy and money printing practice. They will attempt to support the Treasury market when the primary dealers and global participants back away more than they have now. As mentioned above, yields are at historic lows. Doug Noland has this caution in his blog this weekend. "Fiscal and monetary policies are rapidly losing credibility.  Treasury prices may be inflated, but don’t mistake this for confidence in our system’s “core”." Financial markets around the world are expecting a return to quantitative easing (QE3) sometime soon. Bernanke is speaking at the annual Fed Conference at Jackson Hole where last year he hinted at QE2. The world will wait for his message on Aug. 26. Calculated Risk has a post on what he expects from this years Jackson Hole speech. There is a building awareness that the Fed is wrecking the currency. On top of the loss in confidence for the US government, the reaction to a new plan of quantitative easing does not guarantee support for financial markets. Doug Noland writes "The American people no longer buy the notion that piling on more debt and “money printing” offers a reasonable solution.  They are appreciating that it’s instead the problem, and there will be less tolerance for this “experiment” going forward."

Economic Condition Review: June 2011

The last economic review I did for the blog was in January 2011. At that time conditions for the US economy felt hopeful with corporations getting ready to announce good to great business results and guardedly optimistic business outlook messages. Food and energy inflation were an established factor in the US and the rest of the world. QE2 was adding fuel to inflation and to the prices for most commodities, especially the money hedges, gold and silver. The US$ was weakening, reaching a recent low near 73 (see graph below). A review of the weekly market data for January 14 is linked here. Company share prices elevated for much of the early part of earnings season before hitting a ceiling in mid February and suffering a March pullback in sympathy with Japan's enormous tragedy trio, earthquake, tsunami and nuclear power plant catastrophe's. The US markets recovered to the year-to-date high at the end of May.

Now in June, the world is captivated with concern about the bank and sovereign debt crisis in Greece. The concern is over the terms by which it will be resolved and when. The political forces are at work, the ECB, the IMF, and the US Fed are all applying pressure. The Financial Times describes the situation as "A Defining Moment for Greek Debt". A play on words since the article is about the definitions given to what everyone perceives to be a 'credit event' in Greek sovereign debt, involving credit default swaps. Eurozone forces feel the resolution is to deepen the austerity of the Greeks putting the problem on the back of labor as well as insisting that the government sell prime assets, such as state owned transportation and valuable land assets. Bloomberg describes the situation here. The proposals are being met with resistance from Greek labor unions. It remains to be seen how the government decides what to vote. Will they shun the political force representing the banking/eurozone interests or will they adopt an Iceland type reform to protect their assets from fire sale and force losses on the financial system. If they choose the latter, the potential exists for wide ranging credit related losses for European banks and possibly other money center banks around the world too.

The US Fed has announced they do plan to end QE2 as planned at the end of June. Until then, they are still in the markets supporting asset prices. A widely held view, that I share, is that there will be some form of market manipulation choreographed by the Fed until they get enough political support for the next QE. It will take a good financial scare to move the political will, so this is the time to be patient, waiting to take on risk. John Hussman writes that more QE will be politically aggressive in the face of a discouraged populace and critical global community. In addition, the lack of evidence that QE has been successful would support its abandonment. But the final decision likely revolves around the determination of Fed Chairman Bernanke to maintain the practice.

Economic Condition Review 1Q2011

Looking back on the end of 1Q2011, the world is still reeling from the tsunami and earthquake damage in northern Japan, and traces of radiation turning up in unwanted places like certain food and drinking water sources and in ocean water along the plants. In northern Africa, the civil revolt in Egypt has resulted in the departure of the 4 decades long dictatorship of Hosni Mubarek leaving a power vacuum which will be resolved later, hopefully with a democratically run election. Next door to Egypt, the dictator of Libya is fighting his own countrymen who want him, Muammar Gadhafi, to give up his dictatorship. Other uprisings are beginning to build in several other oil producing countries in the region, including the Arabian peninsula. The threat of crude oil shipments being interrupted is a big concern for all countries importing from this region and is the reason for the multi-lateral military action intensifying now, particularly targeting Libya.

In Europe, the government of Portugal has collapsed. The government voted to not accept more austerity measures which was recommended by the former prime minister and his finance minister. This development is expected to lead to a bailout of the country's sovereign external debt by the European Central Bank and/or the IMF. The financial conditions attached to bailouts have been painful so far for Greece and Ireland. Both of those governments are debating how to incorporate the painful bailout conditions or to default on them. Default is immediately easier and politically popular in the countries. China is concerned with internal high and climbing food and shelter inflation threatening the massive lower classes, potentially destabilizing the power of the ruling party. Published reports claim that interest rate increases are on the calendar in China now to slow lending and personal discretionary consumption.

In the US, the Treasury market is finding some strength on a risk-off move recently. The US$ is weak, currently near the 76 mark. New and existing house sales numbers were reported recently by the Commerce Department and are lower than projections. Nationally, median house prices are now at December 2003 levels. Banks, the primary source of credit for economic expansion, both consumer and commercial borrowers, are lending only to prime customers, letting growth of credit remain below trend. Bank closings totalled 11 in January, 12 in February and 3 through March 25, according to the FDIC. Most businesses do not have pricing power, so prices are holding the line so far despite rising commodity prices. Exceptions are businesses with pricing power such as universities, health care services, food and energy producers. Inflation (see Q4 CPI) for gasoline in 2010 came in at 13.8%, the overall energy component at 7.7%, and in the major grocery store food groups, the index for meats, poultry, fish and eggs posted the largest increase at 5.5 percent.

The Federal Reserve is pulling the strings to guide global perception about the strength of the US$. The Fed has no choice but to continue it's zero interest rate policy and money printing practice. They will attempt to support the Treasury market when the primary dealers and global participants back away more than they have now. How the Fed uses it's power may look different and they will call it by another name to put watchers off the scent. But we are talking about a global economy here. Not just the US. Other major economies are directly impacted by the Fed's actions. So they become partners in the deed and will cooperate to the greatest possible extent. This will buy time. The possible time frames are wide ranging from many months to years. Unforeseen events, natural and physical, with financial consequences are wild cards that can, of course, shorten the time frame by changing the delicate balance in place now.

Economic Condition Review 4Q 2010

As 2010 ended, the wait began for Q4 corporate earnings reporting season. Expected are confirmation of the health of the US consumer and corporate guidance leading to confirmation of an economic recovery that is sustainable. Commercial balance sheets are doing everything possible to restore financial health, including cutting expenses by laying off workers and paying off debt. Banks, the primary source of credit for econimci expansion, both consumer and commercial borrowers, are lending only to prime customers, letting growth of credit remain below trend. Most businesses do not have pricing power, so prices are holding the line so far despite rising commodity prices. Exceptions are businesses with pricing power such as health care, food and energy. Inflation (see Q4 CPI) for gasoline in 2010 came in at 13.8%, the overall energy component at 7.7%, and in the major grocery store food groups, the index for meats, poultry, fish and eggs posted the largest increase at 5.5 percent.

During Q4 2010 the Fed implemented the follow-on to quantitative easing we call QE2. This liquidity program is ultimately responsible for accomplishing one of what has become three objectives (maintain price stability, maintain full employment, and now support reflation of US stock market indexes). Obviously the one objective the Fed is succeeding at is reflation of the stock markets. So far, the Fed is not being successful at their two primary objectives. Now a big question is how can US stocks maintain their advance without the rest of the world's participation. Hello Ben. An answer please.

Economic Condition Review, 3Q 2010

So far, the consumer is missing-in-action in the US economy, placing all the pressure on both commercial and government balance sheets. Commercial balance sheets are doing everything possible to restore financial health, including cutting expenses, mainly by laying off workers and paying off debt. Banks, the primary source of credit for consumers and commercial borrowers, are lending only to prime customers, letting growth of credit remain below trend. Most businesses do not have pricing power, so prices are holding the line. Exceptions are businesses with pricing power such as health care, food and energy. Interesting to include that food inflation is widely recognized in China too. Online newspaper Caixin reports that: A rise in food prices, driven by too much bank credit, quantitative easing measures in the United States, speculation in commodities and natural disasters, was mainly responsible for the worse-than-expected inflation, according to the National Bureau of Statistics.

The government is using it's balance sheet (Federal Reserve as proxy) with the QE2 strategy, with the goals of increasing inflation in assets and stimulating job recovery, by creating new money with serial quantitative easing. John Hussman describes, in his Nov 15, 2010 letter, the financial recovery seen in 2010 as "an "economic recovery" that requires a tripling in the Fed's balance sheet, continues to average 450,000 new unemployment claims weekly, and relies on fiscal stimulus to counter utterly stagnant personal income, is ipso facto (by the fact itself) not a "standard" economic recovery. We have swept an enormous volume of bad debt under rugs, behind dams, and in back of curtains (not to mention in off-balance sheet vehicles such as Maiden Lane that were created by the Federal Reserve). But it is all effectively still there, festering. Meanwhile, our policy makers are trying to reignite financial bubbles in order to create an illusory "wealth effect" to propagate spending patterns that were inappropriate in the first place." These are conditions that are almost identical to a year ago, not overlooking isolated and significant price inflation over the year.

Economic Condition Review Q2 2010

The following is my macro economic review. It is work that I will update at least semi annually. I have not included a review of the size of government debt. The default is that it is too great and is a gigantic concern. There is no doubt. How the concern will be manifested is a more urgent question. Most observers are certain it will  be high inflation. That is logical. However, the force or forces that bring the change on are not known. It could be a bond market crisis or more simply a loss of tolerance of low rates and interest rates forced to rise in order to attract buyers (the so-called bond vigilante's). It could be a populist movement creating an opportunity for a free market action or several other possibilities. The point is, inflation is going to be an unwanted guest in our world, and we don't know when it will arrive or how long it will stay. Economist, Mark Thoma, is optimistic that the Fed has the tools and the skill to pilot us through either inflation or deflation. We'll see. All we can do is keep our eyes open to warning signs like bond market spreads and currency exchange rates for starters. That is what I do in my weekly Market Data post's and the daily currency graph's on the left column.

Economic Condition Review 2010 Q1

At the beginning of the quarter I plan to update my economic observations report, to share with interested readers. The following charts are linked from the St Louis Federal Reserve. They help me to document facts that I consider informative when completing my economic analysis. In the end, I believe that my knowledge is more complete and I am better informed, than if I relied on Wall Street/mainstream sources, to provide useful and thoughtful recommendations. I do this quarterly.

Observations:
Net money supply has increased. View the current five year charts for M1 and M2 below. I am using these money supply measures knowing there are several others, which in my opinion make the same point. However, some analyst's are very opinionated about the use of one measure over another. If anyone has an opinion different than mine, I welcome your comment about this.

Click on charts for larger view