bizzXceleration: Performance, Value and Profit

 

Poking at the Markets

We'll start by inverting our usual order and begin with the markets using the market composite chart we tried a couple of posts ago because it puts all the relevant "new meme" information on one dashboard to see. Now sadly for us we'll have to leave you to decode the real details because each panel deserves its own post. For example the lower left panel looks at rates and Gold and uses the 10YR:3Mo ratio as a indicator for the Yield Curve, which apparently spiked thru the roof. But not because there was a sudden collapse in the credit markets as there was last Fall. Instead the 10Yr (TNX) is still dropping (so much for inflation) and the 3Mo (IRX) headed toward zero even faster. Voila' Spike!

Taking the SPX as THE general asset proxy, and amazing how well the upper left chart is holding steady, notice that the downtrend has converged exactly with the 50% retracement level on the Fibonacci chart. Which turns out to be exactly where the markets ran out of steam Th. and Fr. We REPEAT - what happens when the fragile underpinnings of this market unravel? Can you make it to the exit fast enough? Can all those folks with computers and biga-bucks (a punnish play on big and billion)? In case you're interested this is exactly the catastrophe dynamics that led to the Asian crisis over ten years ago. Check out sandpile catastrophes sometime.

So How 'bout that Economy?

One of the triggers for crossing that Rubicon would be surprises in the economic data - which the markets shrugged of earlier in the week (actually for the last several months) but suddenly paid attention to at the end of the week. Anyway there was lots of economic data that came out this week, none of it good and all of it important. Housing being the most but our buddy CalculatedRisk covers that better than anybody and you'll find links to his analysis in the readings; plus links and excerpts to two really superb pieces telling you what it all means for the "big picture". AT least skim the excerpts, please.

People got a little excited when MtM retail sales didn't do well enough. When you look at it by month and quarter on a YoY basis it clearly got better. In the sense that it's not at death's door. On the other hand retail sales ex-Autos is still down -5% YoY. On the whole sales data seems to be bumping along the bottom, though it's no longer cliff-diving.

The other set of data folks got excited about was Industrial Production and Capacity Utilization. Which was worse in both cases than expected, but again on a MtM basis. And again the YoY data was both slightly better but also still pretty abysmal if not headed for the Abyss. One thing we will point out, though you have to squint a bit, the monthly data shows that both dropped on a YoY basis. Which raises fears of the "recovery" stalling. Oops, not good news at all, is it?

Leading Indicators: What the Components Really Said

The other thing that came out was the Conference Board's Leading Indicators. Fortunately Northern Trust and another blogging buddy (Jake at EconPic) dug into the details. Now the LI include market components and lots of monetary variables, which immediately makes us suspicious. Both the ECRI's LEI and the Conference Board's LI sets have decades of history. BUT none of the history was part of a financial markets crisis nor as aberrational as this one where monetary indicators and market data are so subject to mood swings and policy changes. In other words you almost have to consider throwing them out because the underlying relationships are in question.

We think this composite set makes those points perfectly. The long-term YoY changes compared to GDP would be unambiguously good news. On that basis we're clearly crossing a turning point. On the other hand when you look at the MtM changes by component two things stand out. One, the total change and trend is down, and the non-monetary/market components performed poorly. When you net out the Yield Spread (HINT: see first charts set) and what do you get? We'll settle for OUCH!

The Policy and Pundit-Driven Economy

In the readings you'll find collections covering a lot of bases. We'll particularly draw your attention to the sections on "Re-balancing the World" which discuss trade, exchange rates and China's challenges. Since we've taken real deep divers on that before we'll save some space and not do it again. Another point we've made in the running posts on de-constructing the new shibboleths was that most of the explanations concocted by the pundits haven't held up. Which everyone implicitly admits with the sudden emergence of the new consensus. There's a lot of pontificating by authority figures that's on questionable ground. We'll also mention a post by Paul Krugman in which he shared his pitch from a recent talk at the Rijksbank in Sweden. Very good charts.

He also posted this little YouTube post - taken with think from Woody Allen's "Bananas". Any hint that we might be suggesting that much of the punditocracies pronouncements make as much sense as wearing your underwear on the outside to the authorities can check it is well-founded. Just in case you don't want to learn Swedish, change your underwear every 1/2 hour and be sixteen but would like to have a pretty good grounding on the policy vs. economy situation try this:The Sine Qua Non: Economy, Stimulus and Outlook.

Otherwise may we suggest you prepare to salute el Maximo Jefe,with your portfolio de-maximized!

Partisan Gamesmanship (Update):

Speaking of political unsinn and the dangers thereof a short excerpt pointing to a short daily commentary by a Northern Trust economist has been added to the readings. Frankly we found it stunning because it calls out two very conservative Rep. Congressmen who published a WSJ oped piece repeating the old ideological shibboleths. Not so much technically - though it's good to seem someone of this stature speaking up instead of just ourselves. You have to stop and think about the context. NT manages money for the wealthy, has one of the best and most respected economics groups in the world who's track record is impeccable and such folks never comment on politics. NEVER. To add more fat to the fire we found it thru a bloggining buddy (Prier du Pleiss of Investment Postcards) who runs money in South Africa. The bottomline here is that partisan gamesmanship set us very badly for the crisis, almost collapsed the emergency rescue efforts last Fall thru sheer idiocy, has hampered recovery efforts all along the way and thretens the recovery. And all based on provably wrong ideas, analysis, data and constructs - and we do mean PROVABLY. To throw oxygenated high-octane gas on the fire Stan Collander of Capital Gains and Games takes the same non compos mentas to task for their manipulation of deficit fears, following an earlier piece by Bruce Bartlett (the economic staffer to Jack Kemp who was the principal architect of Reagan's reforms) on Republican deficit hypocrasies. Take it for what it's worth but these people are competent, informed, sophisticated, experienced, non-partisan and scared. Our take is that we're crossing a cusp point where this kind of self-serving politics is dangerous.

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Updates

Partisan Bickering is not the Solution for Fostering Economic Growth The main theme of the opinion piece by Representatives Hensarling and Ryan from Texas and Wisconsin, respectively, in today’s Wall Street Journal (Jeb Hensarling and Paul Ryan: Why No One Expects a Strong Recovery - WSJ.com) is poor economic policy choices of the current administration. To make their case they focus on the Reagan administration’s successful economic policies. The success/failure of economic policy choices can be measured by various metrics. It is well known that the federal budget deficit as a percentage of GDP during the Reagan years has been the largest in the entire post-war period ending 2008 (see chart 1). Therefore, from a fiscal perspective, the perceived success of economic policies of the 1981-1988 period is not a resounding success. Therefore, economic history paints a very different picture from the opinion piece of representatives Hensarling and Ryan. Should political leaders be engaged in partisan rhetoric or in a serious discussion of how to make policy choices that will foster sustained economic growth?

• Republican Deficit Hypocrisy

Paul Krugman Protests Too Much Me Thinks Two excellent posts from Paul Krugman today and yesterday about why for substantive and technical reasons the federal deficit and debt aren't the threats to the economy some say they are.  I agree; substantively there is little to complain about.  The fiscal policy in place over the past year has been a success by any objective measure. But the next to last word in that last sentence -- "objective" is the key.  No matter how much we might wish it to be otherwise, this is anything but an objective discussion. The federal budget deficit and debt are political rather than technical issues and that means dealing with fact isn't likely to change many minds.

Video Clips

• Zoellick on: China, US, Dollar and Outlook, World Economy & Outlook, and Crisis Lessons
• Sir Martin Sorell (of WPP Group) on: Economic LUV Recovery, China Outlook, Exec Compensation & Society, Media Futures
• Susan Sanbanci Dincer (Head, Turkey’s largest bank): Structure/Out for Economy,
• Julian Robertson on: Outlook, Inflation & Markets, Markets & Hedge Funds, and Gold, etc.

Economic News & Information

Employment, Data & Outlook

Accumulated Musings Although the forecast on an annual basis has changed little from last month, we have raised our GDP growth estimates meaningfully for the fourth quarter of this year and the first quarter of 2010. We have provided a table showing the changes in the forecast. You will notice that the sectors accounting for the bulk of the increases in projected real GDP growth are business and residential investment. Business equipment spending is rebounding faster than we expected, but by no means are we projecting a capital spending boom. The same holds true for residential investment expenditures. But we believe that the rebound in housing will be quite modest after the third quarter’s 23.3% annualized surge. But what does this have to do with what I started out talking about – the alleged dollar carry trade? My hypothesis is that investors, rather than borrowing dollars, are selling U.S. Treasury securities that they already owned, selling them ultimately to capital-concerned/constrained banks, and are then investing the proceeds in higher-yielding foreign government securities. This would result in a weaker dollar, but does not entail any net new credit creation as banks are reducing their holdings of non-Treasury debt by more than they are increasing their holdings of Treasury/Agency debt. The upshot? Worries about a new credit bubble from a dollar carry trade are much ado about nothing. Why is gold glittering in terms of the dollar and other major currencies? Because investors cannot get an inflation-adjusted positive return on their short-term investments. This certainly is true in dollar terms, as shown in Chart 5. But it might come as surprise to some that it also is true in Euro terms as the three-month EURIBOR interest rate is the same as the three-month annualized euro-zone CPI inflation rate (see Chart 6). When global investors are unable to get an “honest” return on their short-term investments in major currency markets, they historically have turned to gold. If ever there were a nattering nabob of negativism, it would have to be the editorial board of The Wall Street Journal. It just cannot bring itself to admit that the fiscal stimulus program has stimulated some aggregate demand and some aggregate production.

• Recession is History, Economy Back in Business
• Consumer Spending - Mild Increase in Q4
• Will Real GDP Growth in the First Year of Recovery Match Historical Norm?

The Worst is yet to Come: Unemployed Americans Should Hunker Down for More Job Losses Think the worst is over? Wrong. Conditions in the U.S. labor markets are awful and worsening. While the official unemployment rate is already 10.2% and another 200,000 jobs were lost in October, when you include discouraged workers and partially employed workers the figure is a whopping 17.5%. While losing 200,000 jobs per month is better than the 700,000 jobs lost in January, current job losses still average more than the per month rate of 150,000 during the last recession. Also, remember: The last recession ended in November 2001, but job losses continued for more than a year and half until June of 2003; ditto for the 1990-91 recession. So we can expect that job losses will continue until the end of 2010 at the earliest. In other words, if you are unemployed and looking for work and just waiting for the economy to turn the corner, you had better hunker down. All the economic numbers suggest this will take a while. The jobs just are not coming back. There's really just one hope for our leaders to turn things around: a bold prescription that increases the fiscal stimulus with another round of labor-intensive, shovel-ready infrastructure projects, helps fiscally strapped state and local governments and provides a temporary tax credit to the private sector to hire more workers. Helping the unemployed just by extending unemployment benefits is necessary not sufficient; it leads to persistent unemployment rather than job creation. The long-term picture for workers and families is even worse than current job loss numbers alone would suggest. Now as a way of sharing the pain, many firms are telling their workers to cut hours, take furloughs and accept lower wages. Specifically, that fall in hours worked is equivalent to another 3 million full time jobs lost on top of the 7.5 million jobs formally lost.

• One million Workers to Exhaust Unemployment Benefits in January
• The Next Stimulus: "Jobs, jobs, jobs, jobs"
• Unemployment Rate Increases in 29 States in October
• Krugman Suggests $300 Billion Jobs Program
• Free to Lose

Housing Starts and the Unemployment Rate This is an update to an earlier post. As I've noted for some time, housing leads the economy and is the best leading indicator for the economy - both into and out of recessions. Update: Employment tends to be a coincident indicator into recessions, and used to be coincident coming out of recessions. Employment has lagged the economy after the previous two recessions (and appears to be lagging again). Employment lags housing, and the following graph shows the relationship between starts and unemployment. You can see both the correlation and the lag. The lag is usually about 12 to 18 months, with peak correlation at a lag of 16 months for single unit starts. The 2001 recession was a business investment led recession, and the pattern didn't hold. This suggests unemployment might peak in Spring 2010. Professor Fisher argued that unemployment will rise to about 10.4% and then fall rapidly. He is now projecting unemployment will decline to 8% by the end of 2010. He is basing the rapid decline in unemployment on a "V shaped" housing recovery similar to previous recessions. I disagree with that point. In most earlier recessions, the slumps were caused by the Fed raising interest rates to fight inflation. When the Fed cut rates, housing bounced back sharply (V shaped). Although this recession was led by a housing bust - and that makes it look similar to some previous periods - this recession was not engineered by the Fed raising rates, rather it was the busting of the credit and housing bubbles, and all the related problems that led the economy into recession. Since there is still far too much existing home inventory, a sharp bounce back in housing starts is unlikely, so I think Fisher's forecast for a rapid decline in unemployment is also unlikely.

• Housing Starts Decline Sharply in October
• Housing Starts and Vacant Units: No "V" Shaped Recovery

Housing Leads the Economy, Existing Home Sales are Irrelevant  After reading some of the commentary regarding the housing starts report this morning, it might be useful to reiterate these three points:·  Residential investment is the best leading indicator for the economy. ·  Residential investment will not recover rapidly because of the large overhang of existing vacant housing units. ·  Existing home sales are largely irrelevant for the economy. Residential investment is reported quarterly by the Bureau of Economic Analysis (BEA) as part of the GDP report. We can also use monthly housing starts and new home sales as indicators of residential investment. I've written extensively about how residential investment is an excellent leading indicator for the economy (also see Dr. Leamer's paper: Housing and the Business Cycle) This morning several commentators suggested that housing starts were depressed in October because of the expiration of the tax credit (new home buyers had to close by Nov 30th to get the tax credit), and also because of the weather. Probably. But the key point is that housing starts will not increase rapidly because of the large overhang of existing vacant housing units (see 2nd graph here). And that suggests that the economy will not recover quickly either. Another key point is that existing home sales are largely irrelevant for the economy. This is an important point to remember next week when the NAR announces that existing home sales surged to 5.8 million units or so in October (seasonally adjusted annual rate). Some reporters and analysts will jump on the existing home sales report as evidence of a housing recovery. Others will point to it as showing that the first-time home buyer tax credit is helping the economy. Both points are wrong. The only contribution from existing home sales to the economy are some commissions and fees. That is good news for real estate agents and mortgage brokers, but not for the overall economy. The good news is the level of inventory for new and existing homes is declining. The bad news is the inventory of rental units is at record levels - as is the combined inventory of vacant single family homes and rental units. Residential investment will not increase significantly until this overhang is reduced. The key to reducing the overall inventory is new household formation (encouraging renters to become owners accomplishes nothing in reducing the overall housing inventory). And the key to new household formation is jobs. And usually the best leading indicator for jobs is residential investment. Somewhat of a circular trap. And that suggests the recovery will be sluggish and unemployment will stay high for some time.

• Moody's: CRE Prices Off 43% from Peak
• A Few House Price Forecasts

Retail Sales Increase in October On a monthly basis, retail sales increased 1.4% from September to October (seasonally adjusted), and sales are off 1.7% from October 2008. Excluding auto sales and parts, retail sales rose 0.2% in October. The increase in October was mostly a rebound from the decline in September. This graph shows retail sales since 1992. This is monthly retail sales, seasonally adjusted (total and ex-gasoline).This shows that retail sales fell off a cliff in late 2008, and appear to have bottomed, but at a much lower level.The red line shows retail sales ex-gasoline and shows there has been little increase in final demand. The second graph shows the year-over-year change in retail sales since 1993.Real retail sales declined by 1.7% on a YoY basis. The year-over-year comparisons are much easier now since retail sales collapsed in October 2008. Retail sales bottomed in December 2008. It appears retail sales have bottomed, but there has been little pickup in final demand.

• Retail Sales Upside Suprise... Still Weak Longer Term

More on Industrial Production It is too early to tell, but those expecting a "V" shaped recovery would expect industrial production to be tracking at or above the "severe recessions" line (since this was the worst recession since the Depression).

• Industrial Production, Capacity Utilization Increase Slightly in October
• No Inventory Correction in September

Recovery in developed economies gathering pace Economic recovery in the world's developed countries will accelerate next year due to "substantial improvements" in financial markets but is likely to remain fragile, the Organization for Economic Cooperation and Development said Thursday, as it doubled its growth forecast for 2010. The Paris-based watchdog's chief economist, Jorgen Elmeskov, told a news conference that the recovery has been mostly driven by government stimulus measures and interest rate cuts. Those benefited financial markets, whose recovery is "considerably faster and stronger" than anticipated in the June economic outlook, he said. Still, the recovery will remain modest next year, with the U.S. and Japan outpacing Europe, the OECD report said. Elmeskov warned banks not to use the "fat margins" they have accrued thanks to government policies designed to keep money flowing to the real economy to line their own pockets. He said the margins "are the result of both weak competition in the sector and public policy interventions." "It is important that these fat margins do not just end up as higher bonuses, dividends or buybacks." The U.S. economy has been boosted by stimulus measures, improving financial conditions, demand from the fast-growing non-OECD economies of Asia -- especially China -- and the stabilization of the housing market, the OECD said. It predicted unemployment will start to ease after peaking in the first half of 2010. The OECD predicts the U.S. economy will expand at a rate of 2.5 percent in 2010, up from a June forecast of 0.9 percent. It also expects a smaller contraction this year: a 2.5 percent fall in output compared with an interim September forecast of a 2.8 percent drop.In Europe, the economies of the 16 countries sharing the euro are now expected to grow by 0.9 percent next year compared to a June forecast of zero growth. However, the OECD predicts a greater contraction of 4 percent this year, more than the 3.9 percent it calculated in September.Unemployment is not set to peak before the end of 2010 or the beginning of 2011, and is likely to sap the strength of recovery, the OECD said. Japan's economy will grow by 1.8 percent next year compared with the June forecast of 0.7 percent. The OECD reduced prediction for a contraction this year to 5.3 percent compared to a 5.6 percent rate seen in September.Elmeskov said central banks should keep interest rates low and should beware of the dangers of deflation, while governments should work on plans to reduce debt levels as the economy recovers.

Re-Balancing the World

Stronger Yuan Needed for Global Rebalancing: IMF Chief A stronger Chinese yuan is part of the reforms that Beijing needs to implement to increase domestic consumption and help ease global imbalances, the head of the International Monetary Fund said on Monday. IMF Managing Director Dominique Strauss-Kahn said the countries at the heart of global imbalances needed to take various measures to ease them. In the case of China, that means an increasing emphasis on domestic demand, especially private consumption, Strauss-Kahn said in remarks prepared for a financial conference in Beijing. "A stronger currency is part of the package of necessary reforms," he said. "Allowing the renminbi (yuan) and other Asian currencies to rise would help increase the purchasing power of households, raise the labour share of income, and provide the right incentives to reorient investment."

• China has now become the biggest risk to the world economy
• China faces asset-bubble risk, PBOC adviser Fan says

World Out of Balance China is the great exception. Despite huge trade surpluses and the desire of many investors to buy into this fast-growing economy — forces that should have strengthened the renminbi, China’s currency — Chinese authorities have kept that currency persistently weak. They’ve done this mainly by trading renminbi for dollars, which they have accumulated in vast quantities. And in recent months China has carried out what amounts to a beggar-thy-neighbor devaluation, keeping the yuan-dollar exchange rate fixed even as the dollar has fallen sharply against other major currencies. This has given Chinese exporters a growing competitive advantage over their rivals, especially producers in other developing countries. What makes China’s currency policy especially problematic is the depressed state of the world economy. Cheap money and fiscal stimulus seem to have averted a second Great Depression. But policy makers haven’t been able to generate enough spending, public or private, to make progress against mass unemployment. And China’s weak-currency policy exacerbates the problem, in effect siphoning much-needed demand away from the rest of the world into the pockets of artificially competitive Chinese exporters. But why do I say that this problem is about to get much worse? Because for the past year the true scale of the China problem has been masked by temporary factors. Looking forward, we can expect to see both China’s trade surplus and America’s trade deficit surge.

• What rebalancing of Chinese and American consumption?
• Lecturing each other on trade
• Exchange Rates Aren’t the Problem, or the Solution
• Turbulence Isn't Chaos: Dollar, Rates, Trade and Markets

The Great Wallop The Chimerican era is drawing to a close. Given the bursting of the debt and housing bubbles, Americans will have to kick their addiction to cheap money and easy credit. The Chinese authorities understand that heavily indebted American consumers cannot be relied on to return as buyers of Chinese goods on the scale of the period up to 2007. And they dislike their exposure to the American currency in the form of dollar-denominated reserve assets of close to $2 trillion. The Chinese authorities are “long” the dollar like no foreign power in history, and that makes them very nervous. Yet there is a strong temptation for both halves of Chimerica to keep this lopsided partnership going. The reality, however, is that an end to Chimerica is in the American interest for at least three reasons. First, adjusting the exchange rates between the currencies would help reorient the American economy — primarily by making American exports more competitive in China, the world’s fastest-growing economy. Second, an end to Chimerica would lessen the potentially dangerous reliance of American economic policy on measures to stimulate domestic purchasing. American fiscal policy is clearly on an unsustainable path, and the Federal Reserve’s negligible interest rates and the printing of dollars are artificially inflating equity prices. Finally, renminbi revaluation would reduce the risk of potentially serious international friction over trade. The authorities in Beijing must be made to see that any book losses on its reserve assets resulting from changes in the exchange rate will be a modest price to pay for the advantages they reaped from the Chimerica model: the transformation from third-world poverty to superpower status in less than 15 years. In any case, these losses would be more than compensated for by the increase in the dollar value of China’s huge stock of renminbi assets. It is also in China’s interest to kick its currency-intervention habit. A heavily undervalued renminbi is the key financial distortion in the world economy today. If it persists for much longer, China risks losing the very foundation of its economic success: an open global trading regime.

• Miracle or Mirage? "China Is Very Much at Risk," Gary Shilling Says
• China's Not the Disaster-in-the-Making You Think It Is

China’s Sprint for the Gold Over the past decade, even as China’s exports have soared, the nation has begun transforming itself from a global font of low-priced goods fueled by cheap labor into a much more diverse and complex economic power. Along with that, it has developed huge disparities of wealth. “There are a lot of billionaires, but there’s also a lot of poverty in China,” says C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington. “It’s a very bipolar society. People have to recognize that both elements are there.” Per capita income, for example, is still small — about $3,200, which is less than 10 percent that of the United States and slightly more than that of Iraq — and many farmers earn less than a dollar a day. Yet China is also home to the fastest-growing number of billionaires. China doesn’t just dominate trade; it scours the globe for resources; doles out multibillion-dollar loans to other developing nations; and holds stakes in Wall Street giants like Morgan Stanley and the Blackstone Group. A nation that sold about 600,000 cars in 2000 is now poised to eclipse the United States and is on course to sell nearly 15 million vehicles in 2009. No country has ever accumulated larger foreign exchange reserves ($2.2 trillion). No country has more Web surfers (338 million).

• Where China outranks the United States
• How to reinvent China’s growth
• Obama seeks change Beijing can believe in,

Lecturing each other on trade Away from music, my meetings in NY and DC were fairly different from the meetings I had in February.  This time around I got the impression that far more people in the US (although still a minority) understand how risky the Chinese recovery has been and how trade tensions are likely to result as a consequence of the stimulus.  In fact I have the sinking feeling that over the next two or three years I am going to find myself spending an awful amount of time thinking or writing about trade disputes between China and the rest of the world. Regular readers know that for me the key source of China’s high savings and trade surplus is the large excess of the growth rate in national income over household income, caused in large part, I believe, by policies that systematically transfer income from the household sector to investment, SOEs and large producers.  Until these policies are reversed I do not think it is meaningful to talk about China’s rebalancing. In that light I read earlier this week a fascinating and perhaps important article by Hung Ho-Fung in the current issue of the New Left Review, in which he argues that China’s development model has left it dangerously vulnerable to changes in US demand, and that these polices include repression especially of rural income. As an aside, this lopsided debate within China between the domestic constituencies (more stimulus) and the internationalists (more rebalancing) reminds me, as I have often said, of the debate over the passage of Smoot-Hawley, which most Americans with knowledge and experience in international economics and finance, including President Hoover, thought at the time a dreadful mistake. 

Policy & Key Factors: Rates, Trade, Debt and Inflation

It’s the stupidity economy OK, maybe a more polite way to say it is this: bad ideas are acting as serious constraints on policy.We’re in a liquidity trap, with interest rates up against the zero bound. This means that conventional monetary policy isn’t sufficient. What should we do? The first-best answer — that is, the answer that economic models, like my old Japan’s trap analysis, suggest would be optimal — would be to credibly commit to higher inflation, so as to reduce real interest rates. But the key thing to recognize about this answer is that it’s all about expectations — the central bank only has traction over expected inflation to the extent that it can convince people that it will deliver that inflation after the liquidity trap is over. So to make this policy work you have to (i) convince current policymakers that it’s the right answer (ii) Make that argument persuasive enough that it will guide the actions of future policymakers (iii) Convince investors, consumers, and firms that you have in fact achieved (i) and (ii). In reality, we haven’t even gotten anywhere near (i): the conventional wisdom is still that any rise in expected inflation above 2 percent is a bad thing, when it’s actually good. So some readers have asked why I’m not making the same arguments for America now that I was making for Japan a decade ago. The answer is that I don’t think I’ll get anywhere, at least not until or unless the slump goes on for a long time. OK, so what’s next? The second-best answer would be a really big fiscal expansion, sufficient to mostly close the output gap. The economic case for doing that is really clear. But Washington is caught up in deficit phobia, and there doesn’t seem to be any chance of getting a big enough push. That’s why, at this point, I’m turning to what I understand perfectly well to be a third-best solution: subsidizing jobs and promoting work-sharing. Call it constrained optimization, where the constraint comes from the power of bad ideas.

• Slides for today’s presentation

Gold prices are a dead giveaway  When can we be sure that economic recovery is in the bag? The world economy seems to be in a much better place today than it was at the beginning of the year. Policymakers haven't repeated the mistakes made during the Great Depression. The banking system seems to be in better shape, thanks in part to a large taxpayer bailout. Asset markets have recovered, suggesting that the earlier collapse in animal spirits may be over. And economists are revising upwards their forecasts for economic activity, concluding that the worst must now be behind us. For all these reasons, investors are increasingly focused on so-called "exit strategies". How and when should economic life-support policies be removed? After all, interest rates in the developed world are at their lowest levels ever, the gentle hum of the monetary printing press can still just about be heard and budget deficits are huge. Are these policies still necessary, or is it time to expect the world economy to stand up on its own two feet? It's easy to be seduced by what I might cheekily call "straight-line economics" – the idea that when the worst appears to be over, the best is just around the corner. Straight-line economics assumes that strong economic growth is a "normal" state of affairs, interrupted only occasionally by pesky recessions. Sometimes, however, economies end up in a different place, based on the physics of bungee jumping. The economy falls off a cliff. Activity drops a long way. Then there's a rebound. For a while, the rebound looks very good and it's easy enough for economists to stick to their straight-line thinking. But the economy never returns to normal; instead it is left dangling by a thread. The straight line simply doesn't apply. If we've learnt anything over the last two or three years, it's that straight-line thinking is pretty hopeless. For the economics profession, it's been a bruising experience. At the beginning of 2007, some economists recognised downside risks, but the consensus view was that, if there was to be an economic slowdown, it would be a so-called "soft landing". For the forecasting community, it was one of the biggest errors ever made.

How long will interest rates stay low? Pay attention to what the Fed does and not just what it says And if somehow the mark does guess correctly, the dealer and his crew always find an excuse not to pay off. Right now the U.S. Federal Reserve is running its own version of the game. The talk by Ben Bernanke and Co. is all about how rates will stay near the current 0% to 0.25% range for “an extended period.” That’s kept asset prices rising. Which is critical to the Fed’s plan to restoring the health of the financial system.  If banks need to raise more capital, and they do, it sure helps if they’ve got a relatively liquid and climbing stock market to sell their offerings into. In Three Card Monte you have to watch what the dealer does and not listen to the patter. In the Fed’s case while its chairman, vice-chairman, and every governor who can command a podium somewhere are talking up the “extended period” promise, the bank is acting to reduce liquidity now. The goal is to get the financial system back to something like normal. Yes, the Fed keeps talking about low interest rates for an extended period. But its actions show that the Federal Reserve is getting ready for the day when the economy and the financial system are ready to return to normal. My best guess sometime in the second half of 2010. The bank’s definition of “normal,” investors should remember, doesn’t include interest rates at 0%.

• When should the Fed raise rates? (even more wonkish)
• Falling U.S. Dollar: It's Lack of Demand, Not Rising Supply, Pharo's Dow Says

Fed's Lacker: Fed Can't be "paralyzed by patches of lingering weakness" First, I think we could see further declines in inflation in 2010; even the possibility of core PCI deflation. I don't think the risk of further declines has "diminished substantially". Second, I think Q3 GDP will be revised down based on subsequent data (like the trade report), and GDP growth will be lower than Lacker expects in early 2010. I think Lacker is overly optimistic on the economy. Also - historically the Fed hasn't raised rates until well after unemployment peaks, and I doubt they will raise rates until late in 2010 at the earliest (and probably later). In the early '90s, the Fed waited more than a 1 1/2 years after the unemployment rate peaked before raising rates. The unemployment rate had fallen from 7.8% to 6.6% before the Fed raised rates. Following the peak unemployment rate in 2003 of 6.3%, the Fed waited a year to raise rates. The unemployment rate had fallen to 5.6% in June 2004 before the Fed raised rates.

Summers, the Chinese and the Deficit Lawrence Summers, the top White House economic adviser, made a point recently that I have not seen anywhere else. Speaking at the New York Economic Club a few weeks ago, he said: … even with the dramatic action of the Treasury and the Federal Reserve, the total level of borrowing in our economy is actually lower than in normal times, not higher. Accordingly, the volume of securities that have to be absorbed by market participants is lower, not greater, than normal.To translate: Even with the big recent increase in government debt, the total amount of debt generated by the United States economy has not been growing especially fast. That’s because the amount of debt being taken on by households and companies has been falling, as they have cut their spending during the recession. Thus the amount of American debt that investors (“market participants”) must buy has not been growing very fast, despite the government’s spending of billions and billions of dollars in response to the financial crisis. You can see why Mr. Summers would be making this point. The implication seems to be that the oft-heard concerns about foreign investors — those in China, above all — potentially losing their appetite for American debt may be overblown. After all, those foreigners don’t buy only government debt. They buy all kinds of American debt, public and private. According to the Federal Reserve’s Flow of Funds data, total nonfinancial debt grew 6 percent in 2008 and has been growing at annual rate of less than 5 percent this year. It grew at least 8.1 percent every year from 2003 to 2007. So does this mean we should stop worrying about the budget deficit? No, certainly not. The deficit is deeply worrisome, and it will need to be one of the Obama administration’s priorities in the next couple of years. Investors are forward-looking, and they surely realize that private borrowing will revive sometime soon. Government borrowing is projected to remain high for a long time, in large part because of the retirement of the baby boomers and escalating health costs. At some point, lenders may well get nervous and interest rates could rise. But the fact is that rates have remained extremely low even as government borrowing has soared in the last year. The slowing of private borrowing helps explain that mystery.

• Debt, Wealth, Finance & Outlook: Sixty Years of Bubbliciousness

To Rise, Inflation Faces an Uphill Climb Inflation numbers might soon start to look scarier, but any inflation flare-up should be short-lived, and might even sow the seeds of its own demise. The Bureau of Labor Statistics releases its producer- and consumer-price indexes for October. October PPI, due Tuesday morning, is expected to edge higher from September on rising food and energy prices.Economists estimate consumer prices, due on Wednesday morning, also rose from September. "Core" CPI, which strips out food and energy prices, was up 1.5% last month from a year earlier, according to economists' forecasts, well below the 2% the Federal Reserve generally considers a tolerable inflation rate. Those figures won't set off inflation alarms. But coming numbers could mark the start of more-notable upward pressure on year-over-year inflation growth, warns David Ader, head of government-bond strategy at CRT Capital. The reason: For the next few months, inflation will be measured against the worst depths of the recession, when prices fell across the board. A weak labor market can keep inflation in check, even if commodity prices rise. Petroleum-related costs account for just 2.3% of U.S. production costs, according to an analysis by Capital Economics. Employee compensation, on the other hand, accounts for 30.3% of production costs.  In fact, if rising commodity prices lead to more corporate cost cutting, then that will put more downward pressure on inflation. To the extent that already-cash-strapped consumers, facing 10% unemployment, cut back on other items to pay for higher food and energy prices, that also will hurt demand, and prices, for everything else. In other words, don't look for today's inflation pressures to last.

• What Stinkin' Inflation? PPI Edition
• Auto Prices and CFC; CPI and Capacity

Velocity of US money supply at long last edging up Despite ballooning Fed reserves to bail out banks, money supply as measured by the growth in money supply with a zero maturity (notes and coins, check accounts, savings deposits and money-market accounts collectively) continues to slow. The slowing growth is contra to what normally happens when the Fed lowers the Federal funds rate. In real terms the growth rate is also slowing. The slowing in MZM growth is a consequence of US banks’ tight lending standards. The trend is likely to continue until the banks relax these standards. Velocity of MZM is at long last picking up after it started falling in the first quarter of 2007 - six quarters before economic growth slumped. The increase in MZM velocity effectively points to increased economic activity. Further increases in this velocity are essential for sustained economic growth. Bottoms in consumer sentiment and MZM growth coincide, emphasizing the importance of improved consumer sentiment to get the economy going.

Markets & Finance News

Currency, Rate and Trade Wars

China’s Liu Says U.S. Rates Cause Dollar Speculation The decline of the dollar and decisions in the U.S. not to raise interest rates have caused “huge” speculation in foreign exchange trading and seriously affected global asset prices, said Liu Mingkang, chairman of the China Banking Regulatory Commission. “The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation,” he told reporters in Beijing today at the International Finance Forum. Liu said this has “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

Bernanke Expresses Worry About Weak Dollar The chairman of the Federal Reserve, Ben S. Bernanke, warned on Monday that high unemployment and a continued reluctance of banks to make loans are likely to slow the economic recovery for the next year. And in a departure from the usual practice of Fed chairmen, Mr. Bernanke expressed concern about the recent fall in the value of the dollar — a concern that could put the central bank under new pressure to push up interest rates. Taken together, the Fed chairman’s comments highlighted the difficulties that policy makers face as they try to pull the United States out of its worst downturn since the 1930s. But he warned that banks are still very reluctant to lend money, especially to small businesses that normally generate most of the new jobs. Though Fed policy makers have begun to debate the need to start raising interest rates, Mr. Bernanke made it clear that high unemployment will trump concerns about inflation and that such a move was unlikely anytime soon. The steep drop in lending stems in part from a new frugality among consumers, which has caused the total volume of household debt to drop for the first time in almost 60 years. But Mr. Bernanke said restrictive lending by banks had had a major impact on small businesses and was likely to slow the recovery and keep unemployment rate — now 10.2 percent — high for some time. The Fed chairman said this recovery, like the previous two, are likely to seem like jobless recoveries, in part because companies have become more reluctant than to rebuild their workforces and have found new ways to increase the productivity of their existing workers.

• Falling U.S. Dollar: It's Lack of Demand, Not Rising Supply, Pharo's Dow Says
• Bernanke And The Buck
• The Fed And Bubbles

An undervalued Chinese currency is bad for the world but could be profitable for you But if you’re an individual investor looking to put money to work, the dollar-renminbi peg is a gift. And you’d better put it to work for you now because it ain’t going to be here forever. The world’s emerging markets appeal to you—these economies look set to grow faster than the United States, Europe, and Japan for a decade or more—but these stocks have had a huge run. Forget getting in through the back door either: The commodity-dominated markets of countries like Australia and Canada have run away from you too. Heaven forbid that you sold something and want to put the money back to work, or, even worse, that you’re coming late to the game and have cash on the sidelines that you want to invest. You ready for the final straw? The currencies of many of these countries are hugely stronger against the dollar than they were at the beginning of 2009. Not only are emerging market and commodity economy stocks more expensive in their own currencies than they were when this rally started on March 9, but theyre extra, super-duper expensive to any investor who needs to buy them with U.S. dollars. Not for the Chinese renminbi and the U.S. dollar, though. Back in July 2008 when China re-pegged its currency to the dollar it traded at 6.8 to 6.85 renminbi to the dollar. Today it trades at 6.8 to 6.85 renminbi to the dollar. Here are five ways that you could make the current dollar-renminbi peg your friend and put the future appreciation of the Chinese currency to work for you.

Markets

Stocks Overvalued, Recession Will Return: Meredith Whitney Stocks are overvalued and the US economy is likely to fall back into a recession next year, well-known analyst Meredith Whitney told CNBC. "I haven't been this bearish in a year," she said in a live interview. "I look at the board and every single stock from Tiffany to Bank of America to Caterpillar is up. But there is no fundamental rooting as to why these names are up—particularly in the consumer space." In a wide-ranging interview, Whitney, CEO of the Meredith Whitney Advisory Group, also said: # She was disappointed that Fed Chairman Ben Bernanke didn't spell out how the Federal Reserve planned to exit "the biggest Fed program to date, which is the mortgage-backed purchase program." In a speech earlier Thursday, Bernanke said the central bank was watching the dollar's decline but is likely to keep interest rates low. # The US consumer was going through the biggest credit contraction ever—even bigger than that during the Great Depression. "That credit contraction is accelerating," she said. "There's nowhere to hide at this point." # The banking sector is not adequately capitalized and will need to raise more capital in the coming year. # The residential real estate market is likely to worsen and remains a much bigger threat than the commercial property market. The government's mortgage modification program won't result in any major improvement in homeowners' ability to stay above water, she added. "I don't know what's going on in the market right now because it makes no sense to me," she said. "The scariest thing about the Fed's program is that the money on the sidelines isn't going to support that asset class," she added. "So the trillion dollars of Fannie (Mae), Freddie (Mac) and mortgage-backed securities that the Fed is holding—there's no substitute buyer there."

• What It Would Take to Get Bearish Gary Shilling to Say, "I'm Dead Wrong"
• The Market Surges, and Even Meredith Whitney Can't Stop It
• ABC Investing: "Anything But Cash" Keeps Driving Stocks Higher

You may not like the fundamentals but this rally is headed higher The test is over. And the stock market rally has passed. On November 16, the Standard & Poor’s 500 and the NASDAQ 100 both joined the Dow Jones Industrials in setting new recovery highs. In other words all three indexes have busted out of the trading range of 1025 to 1098 on the S&P 500 that had threatened to keep stocks locked up in a narrow band for more than a month after that October low. On November 16, the Standard & Poor’s 500 closed at 1109, well above the 1098 high set on October 19. The Dow Jones Industrials closed at 10407. The Dow Industrial Average hasn’t been that high since October 2008. The NASDAQ 100 closed at 2198, a level that index hasn’t seen since November 2007. On November 12 I wrote that the market would either break above 1098 on the S&P, signaling that we were headed for a new recovery high and that the rally was alive and well or fail the test and sink back toward the lows at 1025. When the market is in a rally each high will be higher than the one before and each low will be at a higher level too. So the action of the last few days says that this rally still has a way to run. How far? As far as I’ve written repeatedly lately as the flood of global liquidity, borrowed dollars flowing into commodities, and a falling U.S. dollar can take it. Through the end of the year certainly and probably deep into the first half of 2010. The only things that could derail the rally at this point are an interest rate increase from the Federal Reserve that drove up the price of the U.S. dollar, believable promises from developed economy central banks that they are going to remove stimulus funds from the economy, or convincing evidence that the global economy—or at least a handful of the economies that count such as China, the United States, India and Germany—were growing much, much more slowly than anyone had projected. Any of those three events is possible. But each of them would take time to develop into a convincing argument for selling. I think this rally continues to have legs. It is worth investing in or staying invested in. But don’t forget that this rally hangs on two assumptions. First, that the global economic recovery has gained enough momentum that it will be sustainable in 2010. No back sliding into a double-dip recession. And second, that none of the world’s significant central banks is going to start tightening money supply until way into 2010 at the earliest.Neither of those is guaranteed.

XLF Triangle Here is a 60-minute chart of the XLF showing a symmetrical triangle outlined in blue (click to enlarge): The purple line gives the height of the triangle. The green line is the same height as the purple line and shows the 100% extension for a breakout. The red line shows the target for breakdown. So, the XLF is geared to either test the October 14th top, or the November 2nd bottom.So, as The Fly says: To the FAZ-mobile! Or the FAS-mobile. Or SKF/UYG if you prefer. I suppose that the CPI report Wednesday morning could call the direction. A little pop in inflation might make traders think that the Fed will tighten sooner, and that might be bad news for the banks. If the number is in-line, then take a look at market breadth after the open; strong breadth would give the edge to an upside breakout. Also, the swing down Tuesday morning did not reach the lower triangle line (blue arrow on chart), and that may be a bullish implication signifying impatient dip buyers. The BKX banking index has the same triangle, however, it was able to break above the upper line during the last half hour of trading today. And both the XLF and BKX have moved above all the important moving-averages on the 15-minute chart.

When bad news doesn’t take stocks down, the rally is still in charge Stocks are hanging tough in the face of some heavy duty bad news. For the last two days, November 17 and 18 the Standard & Poor’s 500 has refused to drop below 1100. That’s often a sign that stocks are ready to move higher when the bad news flow stops. How bad has the news been? Heavy duty bad. On November 18, for example, investors got early morning news that housing starts had collapsed in October. Starts fell by 10.2% to 529,000 from 592,000 in September. That was a huge negative surprise. Wall Street had be3en expecting that starts would inch ahead to 600,000 for the month. And a huge disappointment to investors who had convinced themselves that the economy was on the mend after starts climbed to 593,000 in July. Starts stayed at about that level in August and September. With the economy returning to growth in the third quarter—and at a very healthy 3.5% annual rate too—there seemed to be solid evidence that housing, the sickest sector of the economy, was headed to the recovery room. The recent numbers threw that all into doubt. The pattern the day before was similar. Bad news on weaker than expected U.S. manufacturing activity couldn’t even keep stocks down for the day. On November 17 the S&P 500 actually climbed by 1.02 points. Not much. But any gain in the face of bad news is an indicator of how strongly the stock market is being pushed up by cash flows.In fact it helps to understand this market in terms of a battle between economic news and fears, on the one hand, and cash flows into U.S. equities (and commodities and overseas financial markets). Right now cash flows are strong enough to outweigh some pretty negative economic news. It won’t always be this way. But right now cash trumps news. The trend is still up.

• My guide to how to worry: Know what to worry about and when if you don’t want to get spooked out of a rally–or get killed in a correction
• After this rally I’m still waiting for signs that the economy is in a sustained recovery

6 REASONS RICHARD RUSSELL WANTS TO OWN GOLD There are a number of items favoring higher gold now. (1) Interest rates are at zero, which means the “opportunity cost” of owning gold now is highly favorable. You sacrifice no yield in owning gold vs. Treasury bills. T-bills pay you nothing, so you might as well have your money in gold. (2) The Bernanke Fed will evidently stop at nothing in its all-out attempt to “jump start” the wobbly US economy. This means spending and building debt at a never-seen-before rate. This will result in inflation. (3) The world’s central banks are now seeking to protect themselves from a falling dollar by buying gold. After years of selling gold,ironically, the central banks are now buying gold.

• Is Gold Really in a Bubble?
• Parabolic Gold
• Gold? Try Palladium!
• A Déjà Vu Moment in Gold?

The quant bubble Keep dancing if you will, but I continue to sit out the melt-up in stocks and the bubble in other asset classes. When investors/traders are arguably overinfluenced by prices (not fundamentals) that dominate the markets, and are all on a similar side, it has the potential to lead to a treacherous and slippery slope, as it did in 2007-08. Remember, it is some of the same momentum-based quant funds that sold in March 2009 that have been buying over the past few months. I have seen many bubbles in my 30-plus years in the investment business. There is a giant bubble in quant funds, and their outsized influence in buying stocks, bonds and commodities might soon be approaching the height its of popularity.

Investment Strategies

When Common Sense Says It's Time to Sell Just a year ago, as conversations inevitably turned to the plunging stock market, I felt like the odd man out. Most people doing the talking were boasting that they had bailed out, cut their losses, moved into cash, hunkered down. And then I'd say I was buying. Most people looked at me like I was crazy. The deeper the market fell and the longer the correction persisted, the more isolated I felt. So I stopped talking about it, just nodding when the subject arose. Now, with the market continuing to set new highs for the year, most recently on Monday, I'm again feeling isolated. That's because I've been following the Common Sense system, which calls for selling after large gains like the one we just experienced. So while everyone else is celebrating their gains, I'm thinking about what to sell. Don't get me wrong. I'm as delighted as everyone else by the market's rise, since overall, I'm always long on stocks. But I'm not buying when the market hits new highs. Instead, I'm locking in some gains, raising cash for the day when a correction arrives. Over the years I've been doing this, I've come to understand why this doesn't make me all that popular with certain kinds of investors. Many people equate a decision to sell with a prediction the market is going down. Who am I to damp the festive atmosphere of a big rally? But I don't try to predict short- or even medium-term moves in the market. All I'm trying to do is sell higher, buy lower, and thereby outperform a strict buy-and-hold approach. So far it has been working. Earlier this year I was exhorting people to buy, as I did myself. As luck would have it, I bought on March 9, which turned out to be the bottom.

• Wall Street's Alphabet Soup Has Wall Street's alphabet soup given you investing indigestion? No other institution—with the possible exceptions of the government or the military—spews out acronyms and initials quite as prolifically. I call these products of financial engineering "WACronyms," because they tend to sound innocent when, in fact, many of them are full of wacky complications and incomprehensible risks.

Société Générale tells clients how to prepare for potential “global collapse” In a report entitled "Worst-case debt scenario", the bank's asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems. Overall debt is still far too high in almost all rich economies as a share of GDP (350pc in the US), whether public or private. It must be reduced by the hard slog of "deleveraging", for years. "As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse," said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast. Under the French bank's "Bear Case" scenario (the gloomiest of three possible outcomes), the dollar would slide further and global equities would retest the March lows. Property prices would tumble again. Oil would fall back to $50 in 2010. Governments have already shot their fiscal bolts. Even without fresh spending, public debt would explode within two years to 105pc of GDP in the UK, 125pc in the US and the eurozone, and 270pc in Japan. Worldwide state debt would reach $45 trillion, up two-and-a-half times in a decade. (UK figures look low because debt started from a low base. Mr Ferman said the UK would converge with Europe at 130pc of GDP by 2015 under the bear case). The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Ageing populations will make it harder to erode debt through growth. "High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt," it said. Inflating debt away might be seen by some governments as a lesser of evils. If so, gold would go "up, and up, and up" as the only safe haven from fiat paper money. Private debt is also crippling. Even if the US savings rate stabilises at 7pc, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.

Nervous? Afraid to stay in but scared to get out? Join the club (and read my three strategies for coping) Feeling twitchy?Your portfolio is probably full of stocks trading at 52-week highs. And I’ll bet you’ve thought about selling. And you would do that–except that the stock market keeps going up (well except for the last couple of days), cash pays close to nothing, and it’s hard to find a stock to buy that’s not already trading at its 52-week high. I think you’ve got three choices at this point in this stock market. [ …] I think there are problems with each of these three strategies. But I do think that if you take a dash of this and mix it with a pinch of that, you can come up with a strategy that limits risk and gives you decent upside exposure. Let me lay out that hybrid strategy for you and suggest a few stocks suited to playing mix and match. First, build a cash management plan—and put it into effect. Second, momentum is real and it can be your friend if you let it. Over and over during this rally I’ve heard from investors who have said, The stock market is ahead of the fundamentals of the economy or “This rally is built on nothing but the world’s central banks flooding the financial markets with liquidity.”

I totally agree. This is a liquidity driven rally. It is based on the huge influx of cash from government stimulus programs in countries such as the United States and China. The rally in commodities, commodity stocks, and emerging economy stock markets has been funded by money borrowed in what’s called the dollar carry trade. Third, the skeptics could be wrong and fundamentals could still count. In which case you should be now buying the great fundamental companies of 2010. The argument that this is just a momentum rally based on massive flows of global liquidity is based on two things. Huge observed flows of capital. I don’t think this is subjective or debatable. A profound disbelief in an earnings recovery in 2010. This is subjective and debatable. We simply don’t have the data yet to tell us how strong individual global economies will be in 2010. And we don’t know how sustainable any economic recovery might be.But we do know that the year to year comparisons in the March and June quarters of 2010 are going to be to some terrible quarters in 2009. In other words it won’t take much for earnings to look better on a year to year basis. And we do know that some companies are coming out of this recession as lean, mean earnings machines.