Production Index on Brink of Collapse 15 comments
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On Monday the Federal Reserve announced the Industrial Production Index (IPI) figures for the month of February. The IPI fell to the level of 99.7298. This is 1.93% above the December 2001 level of 97.8399. Falling below the Dec. 2001 level would bring economic activity to the dark ages for all intents and purposes.
Warning: the following charts may cause severe and/or permanent eye damage. Avert your eyes if you start to feel the signs of fatigue, drowsiness, or nausea.
click to enlarge
For all I know this is do or die for the U.S. economy. Because the IPI is a lagging indicator as part of Dow's Theory, we can only guess that as the Dow Industrials and Dow Transports have bottomed on March 9th we might be in the midst of a temporary bottom. How do I know? I don't know. However, the economic data that is coming out recently isn't worse than what would be expected as the "experts" have baked in much of what is known to be on the horizon.
My opinion is that we aren't out of the woods but we are well on our way to a natural reaction to the oversold conditions in the market and the economy. However, be prepared for new and unforeseen realities that the market has to offer. As an example, what would happen if a medium sized holder of treasuries decides to sell all of their holdings? The shock to the financial system would be profound and unexpected since everyone is waiting on pins and needles for China or Japan to pull the trigger.
Usually it is the unexpected and smaller players that can disrupt an entire system, like what occurred in Thailand in 1997 or Austria in 1931. As the prevailing logic goes, China and Japan have too much at stake to actually sell their U.S. treasuries, therefore it is fitting that they wouldn't engage in the activity as readily as, say, ______________________(fill in the blank).
As with every snowball, all it takes is a small player to get things started. The rest becomes a matter of flooding the exits. The last thing we need in this economy is rising interest rates due to the forced selling of treasuries. This would be the final blow to the perception that the economic "crisis" can be contained. However, it is this scenario that has the highest probability of occurring as a sort of "black swan" event.
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This article has 15 comments:
Instead of charting, I'd look at factors in the economy, such as housing starts, net asset values of the economy as a whole, and the like. Even with this macro-view, I think the buy-sell decision for a myriad of stocks are unaffected by it, in that the bad news is either already priced in (stocks are a leading indicator), or the fundamentals for the underlying stock are much, much stronger than the economy as a whole (Intel, Exxon, for instance).
Finally, your fear of Treasuries seems to be just that - fear. There's not much of a reason to suggest that the Treasury market is a house of cards, is there? Minor players will affect the yield in a minor way, and the Fed has already suggested that it will keep the long end of the curve down at all costs while the economy recovers. I agree with you that major players have all the reason to stay in...so why spread unfounded rumors around about systemic risk?
And I agree. So you see, there is a reason to suggest treasuries are a house of cards.
On Mar 17 09:29 PM @TexasER wrote:
> Richard, fear is the very reason treasuries may collapse. The author
> isn't the only one speculating about this. Warren Buffet has suggested
> it as well.
>
> And I agree. So you see, there is a reason to suggest treasuries
> are a house of cards.
Fed purchase of longer-term treasuries is printing of money, pure and simple. I do not like the idea that my hard-earned dollars are chasing after the same goods and services as dollars printed out of thin air by the federal reserve. I wonder if the Chinese feel the same way?
There's China, wanting to buy oil, copper, pork, soybeans, wheat, willing to exchange the fruits of their labours as payment. Then there's the US, wanting the same goods, offering digital units that Bernanke created by pushing a key on his computer.
If I was Chinese, I might cry foul.
I have to admit that I had to jazz up the title otherwise the SA team would give it a title that would be worse. It's better to control your content rather than someone else. Although I can understand the confusion you may have had with the content and the title. On my blog the title is more aptly stated as "Industrial Production Index Fence Sitting."
If you followed my blog then you'd see that I like to use Charles Dow's theory for technical analysis (TA.) This outdated TA approach is the basis for almost all modern TA in the United States. I'm not claiming that this theory is the basis of all TA in the world, just that, in the US, the majority of TA is derived from this source.
To your question of why I'm using TA for an economic indicator and not trying to divine all the data that exists. The answer is in the fact that, as Dow's Theory states, all the knowledge that exists is compiled in the Dow Transports, Industrials and the Barron's Business Index. Since the Barron's Business index was discontinued in 1938 my research indicates that the Industrial Production Index has a high correlation with Barron's Business Index. Again, the point of Dow's Theory is that it imputs all the known variables and synthesizes this information through the three aforementioned indices.
Regarding your comment about Treasuries, I don't have a fear of the impact of treasuries. I am only restating a common concern whether real or not. However, I'm fine with the fact that you have no doubt about the Fed's ability to assuage any concerns on the issuance of treasuries along with the government's impeccable balance sheet.
I am anxious to see your blog or website that has compiled your detailed take on the economy in a format that doesn't accuse others of "...spread[ing] unfounded rumors..." However, your thoughtful critiques of my work are certainly appreciated. After all, I have everything to gain and nothing to lose from the experience.
Thank you for your time and consideration of my material.
The fact that they (The Fed) has continously reiterated the economy is fine as we've watched it slide into oblivion shows that the Fed doesn't have the control that you seem to believe.
Thanks for the reply. Like you, I have everything to gain from this experience and nothing to lose. However, I have no blog, and do not gather data to publish in any capacity. My main point is that I've yet to see any evidence of what you cite regarding a potentially uncontrollable run on Treasuries. Perhaps if you had a certain party in mind, whom the Fed could not adequately counter through the means at their disposal, then I would take back my accusation. But, as it stands, your comment certainly resembles a rumor, and it doesn't seem to have any evidence behind it to back it up, so I find my accusation valid. I do not mean to be insulting, I mean it to be constructive criticism. I hope you take it in the same spirit.
Anyway, keep up the good work, and good luck with your investments.
To Mr. McHattie:
I think we agree but differ in semantics. Your point seems less concerned about Treasuries than the value of the dollar. My prior comment expressed agreement with this sentiment. However, to suggest that treasuries will plummet beyond the Fed's ability to control the yield curve is an entirely different matter, and goes well beyond both a plummeting dollar and a plummeting treasury yield in its effect on the economy, and it is this fact with which I disagree with the author of this article. To me, it is a matter of whether or not the Fed has adequate control of this situation, even assuming massive inflationary consequences. I am challenging the author's assertion that the Fed does not.
On Mar 17 10:38 PM Dividend Inc wrote:
On Mar 17 10:46 PM Dividend Inc wrote:
> As a sidebar, if the Fed was in so much control of the financial
> situation then the very first assurance from the Fed that the economy
> is fine would have solved our problems way back in 2006.
>
> The fact that they (The Fed) has continously reiterated the economy
> is fine as we've watched it slide into oblivion shows that the Fed
> doesn't have the control that you seem to believe.
The Fed, I believe, is interested in domestic price stability, and believes low rates coupled with anti-deflationary measures (printing money) will aid it in its cause. If some outside entity were to sell Treasuries, I believe the Fed will simply buy them back by printing more money. The Fed has pretty much said it will do this over the past couple months, even if China or Japan turn out to be the sellers - domestic price stability, and its effects on housing and mortgages, seem to trump other concerns at the Fed. This includes depreciation of the dollar internationally.
Because most entities holding large amounts of dollar-denominated debt do not want to see these assets depreciated, they are essentially held hostage by the Fed and the US economy. They don't like it, but they know they have to play the game by our rules. Does this undermine our credibility overseas? You betcha. Does it keep our people safe through this crisis? The Fed is betting that it will.
It is in this vein of reasoning that I see the Fed keeping a tight reign on the Treasury yield, damned its effects on the currency internationally. As long as WE are safe...that's the Fed's area of responsibility, unless we've added more states to the union that I don't know about...
Right now the only thing really supporting Treasuries is the fact there isn't a readily replaceable safe substitution investment, although China has silently tried to buy commodity producers here and there.
Simply put, there is very few assets that can support trillions of dollars without causing a massive imbalance (as in they will get so pricey and scarce that you can't afford them). It just goes to show, we made a lot more money than anyone can ever use besides buying more treasuries which goes towards making more money.
It's a virtuous cycle but not so virtuous.
"#1: conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
#2: supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers
#3: maintaining the stability of the financial system and containing systemic risk that may arise in financial markets ."
If these three of four points mission statements aren't about controlling the economy to some extent then you're right, I confused the role of the Fed.
Source:
www.federalreserve.gov...
On Mar 17 11:13 PM Ricard wrote:
> Whether or not the Fed has control of the economy, and whether or
> not the Fed has control of the treasury yield curve, are two entirely
> different matters. Please do not confuse the topic at hand.
#1 - Statement #1 is about influencing the monetary and credit conditions in the economy, not controlling it. This would corroborate the Fed's emphasis on controlling the yield curve, not controlling the economy. This took center stage a couple of days ago.
#2 - Statement #2 does not overtly nor covertly imply control of the economy. The Fed has its purpose, and if it is doing a good job, it will contribute to the overall health of the economy. In no way does it exert direct control over it. The police do not control the crime rate - they merely attempt to keep it at a level deemed constructive to society.
#3 - Statement #3 is regarding the stability of the financial system (a key factor of which is price stability), again, not controlling the economy. For example, it attempts to contain systemic risk by raising interest rates during a bubble, and lowering them to fight potential deflation. As we can all see and agree with, if the Fed truly were in control of the economy, it would certainly be a very different picture than what it is right now.
This is getting to the point of semantics. In a way, we all control the economy to an extent through our personal decision-making capacities...I thought the point was whether or not the Fed exerted direct control, to which I would like to again emphasize that it does not.
On Mar 19 04:36 PM Dividend Inc wrote:
> If these three of four points mission statements aren't about controlling
> the economy to some extent then you're right, I confused the role
> of the Fed.
>
I know this may seem like an unfair example however I wish to selectively pull comments from Alan Greenspan's opening remarks at a symposium sponsored by the Federal Reserve Bank of Kansas City titled "Maintaining Financial Stability in a Global Economy" at a time when Greenspan was a representative of the Fed in August of 1997.
Greenspan states: "Increased availability of a central bank credit facility, even if not drawn upon, can induce increased credit extension by banks and increased (economic) activity by their customers, since creditors of banks are more willing to finance banks' activities with such governmental backstop available."
This comment is preceded by the point that the Fed's ability to use and control the yield curve using various tools at their disposal directly impacts banks which further impacts the level of economic activity. Were it not for the Fed's role in this process confidence in this system would not exist.
Greenspan states: "Accordingly, central banks must remain especially vigilant in maintaining a proper balance between a safety net that fosters economic and financial stabilization and one that does not."
This underlines the fact that the Federal Reserve understands its role, in part, is for the fostering of economic activity simply by being a safety net that everyone agrees will be there just in case. Without such a "safety net" much of the economic activity in our system would not take place in the same way that we currently expect it to.
Of course this doesn't mean that economic activity wouldn't exist at all if there wasn't a Fed. However, the Fed seems to think that their existence imparts a sense of trust in the economic and financial system that didn't exist before 1913. While I don't believe that the Fed is doing the right things to stabilize the system, I certainly understand what often goes unsaid, the Fed controls the economy.
Your thoughts appreciated.
BTW, The symposium articles can be found at the KC Fed's website. The quotes by Greenspan are found in his opening remarks speech of the same symposium.
To this extent, the Fed wants the long term yield curve to be low while the economy recovers. The Fed has expressed the desire that it is willing to risk much as far as tertiary consequences are concerned to achieve this end. The Fed has backed that statement up with action, the latest example of which we saw a couple of days ago. Yields subsequently fell.
If the long term yield curve remains low, Treasuries will remain expensive (in dollar terms), because its yield will be well below the yield of other investments that may or may not carry similar risk. The Fed does control the Treasury market to this extent. Is the Treasury market important to the economy? Absolutely. Does it control the economy? Absolutely not.
After reviewing your comments, I no longer have an idea what point you are making. Originally, you seemed to assert that the Fed did not have control over the Treasury market, to which I disagreed. Then, you seemed to think that the Fed does not have control over the economy, and then, that controlling the economy is the Fed's job. I'm simply trying to say that the Fed knows that such feats are beyond even its powers to accomplish. You've proven as much by quoting the Fed's mission statements.
Dividend Inc wrote:
> As a sidebar, if the Fed was in so much control of the financial
> situation then the very first assurance from the Fed that the economy
> is fine would have solved our problems way back in 2006.
>
> The fact that they (The Fed) has continously reiterated the economy
> is fine as we've watched it slide into oblivion shows that the Fed
> doesn't have the control that you seem to believe.
Dividend Inc wrote:
If these three of four points mission statements aren't about controlling the economy to some extent then you're right, I confused the role of the Fed.