Jim Welsh on the Economy: Past the Point of No Return

This week I read one of the best essays on the current economy and the headwinds we face in John_Mauldin’s Outside the Box newsletter. The author is Jim Welsh, a long time (since 1979) investment professional and a successful discretionary money manager since 1986. He is the principal of Welsh Money Management LLC. Jim has been publishing a monthly newsletter, The Financial Commentator (available by subscription), since 1985. This essay is from the most recent newsletter. Jim has agreed to let me share this with Seeking Alpha readers.

There are a number of data series that evaluate economic conditions using a diffusion index. A diffusion index will have a value above 50, when a plurality of respondents are positive, and below 50 when a majority are negative. If a diffusion index increases from 35 to 38, it represents a gain of 8.6%, while a rise to 46 from 45 is only a gain of 2.2%. It is natural to think of the larger percentage gain to be more noteworthy. However, the smaller gain is actually more significant, since it will only require a small further improvement, before actual economic growth is achieved. In recent weeks, many economists and market strategists have heralded the end of the recession and the arrival of spring, after spotting a few 'green shoots' of improvement. In most cases, the 'green shoot' was a modest up tick, from a multi-decade low! For instance, the Conference Board's Consumer Confidence Index edged up to 26.0 in March, from 25.3 in February, the lowest reading since records began in 1967.

In February, new home sales were up 4.7% to 337,000, and after that robust increase, were only down 75.7% from their July 2005 peak. In the last three years, housing starts have plunged from 1,823,000 to 358,000, or 80.4%. At the February sales rate, it will take 12.2 months to clear the inventory of new homes for sale, versus 5 months in a healthy market. In the past year, the median price of a new home has fallen from $251,000 to $200,900, a drop of 20%. After retail sales collapsed in the fourth quarter, the inventory-to-sales ratio soared from 1.25 to 1.45, or 16%. Companies were forced to cut production drastically in the first quarter, so bloated inventories could be whittled down. Although the ratio dipped to 1.43 in February, production levels will remain low, until the ratio falls further. The large decline in production will contribute to a fairly weak first quarter, and depress second quarter GDP too.

As noted last month, there is a good chance that GDP will post a positive print in the fourth quarter of this year, and maybe in the third quarter. Most of the 'gain' will be statistical nonsense, but that won't deter most economists from getting excited. In the last 2 years, the 80% plunge in housing starts has subtracted about .9% from GDP each quarter. If housing starts stabilize near February's level in coming months, the .9% hit to GDP will become 0%. If inventories are brought down by the fourth quarter and are in line with sales, the decline of 1% to 2% to GDP from production cuts in the first and second quarter could also improve to 0%. In the fourth quarter last year, personal consumption fell an extraordinary -2.99%, as consumers turned into Grinches.

But consumer spending improved in the first quarter, as government income transfers of $127 billion offset the decline in wages and salaries of $89 billion. In the second quarter, social security recipients will receive a onetime $250 payment in May. Tax refunds are up 11% from last year, and the decline in gasoline prices is also providing a boost to incomes. Consumers will use the extra disposable income to pay down debt, and increase savings and spending. All of these factors should help swing personal consumption to a positive for GDP in coming quarters.

In the second quarter of 2008, GDP grew 2.8%, which is a respectable number. Despite this growth, job losses continued each month, and a self sustaining economic expansion failed to take hold. The most important issue in the next 12 to 15 months is whether the rebound in the second half of 2009 and first half of 2010 will gain enough traction to launch a self sustaining economic recovery. There are many reasons why I remain skeptical.

In the first three months of 2009, more than 2 million jobs were lost, causing the unemployment rate to jump from 7.6% to 8.5%, the highest since November 1983. The unemployment rate increased in March in 46 states, with California, the world's eighth largest economy, hitting 11.2%, the highest since January 1941. Underemployment, which combines the unemployed, with involuntary part time workers and discouraged workers, reached 15.6%.

As noted in recent months, post World War II recessions have on average caused personal income to fall between 4% and 7%, and this one has further to go. Wages and salaries shrank at a 4% annual rate in the first quarter, and according to Deutsche Bank, payroll-tax withholding receipts collected by the Treasury Department are down 8.2% from a year ago. This suggests that personal income growth will remain weak in coming months, and shave more than $250 billion from total income and future demand. Changes in temporary jobs lead reversals in the overall labor market by 6 to 10 months. In 2007, a continuous decline in temporary jobs and hours worked led me to forecast a decline in jobs in 2008. When non-farm jobs fell in January 2008, most economists were shocked, and the stock market sold off sharply. In March, employers cut 71,700 temporary workers, so any real improvement in job growth is many months away.

Most economists are quick to note that unemployment is a lagging indicator, and they're right. But the magnitude of the job losses shouldn't be dismissed so glibly, given the impact they are having on the banking system. The American Bankers Association reported that 3.22% of consumer loans were delinquent at the end of 2008. That is the highest level since the ABA began tracking overall loan delinquency rates in the mid 1970's. And that was before 2 million jobs were lost in the first quarter.

An average of 5,945 bankruptcy petitions were filed each day in March, up 9% from February and 38% from a year ago. The soaring job losses since last September are certainly behind the increase in bankruptcies.

The surge in job losses are working their way up the income ladder, with an increasing number of middle income and upper middle income workers being affected. This is pushing many of those who previously were considered prime credit risks over the edge. Two-thirds of mortgages in the U.S. are held by the best credit risk, prime borrowers. According to the American Bankers Association, 5.06% of prime borrowers have missed at least one mortgage payment. Since prime borrowers are such a large group, this represents 1.8 million mortgages. Although the delinquency rate for sub prime mortgages is up to 21.9%, it only accounts for 1.2 million mortgages.

In the fourth quarter, a number of states mandated a freeze on foreclosures, and a number of banks, not wanting to be a modern day Mr. Potter during the holidays, voluntarily suspended foreclosures. According to RealtyTrac, foreclosure filings increased to 341,180 in March, up 17% from February, and up 46% from a year ago. After the foreclosure moratorium expired in California, notices of trustee sales, which precede foreclosure sales, climbed more than 80% to 33,178 in March from February. Moody's Economy.com estimates more than 2.1 million homes will be lost this year, up from 1.7 in 2008.

Existing home sales have declined 33.3% since peaking in September 2005. The median price has dropped 28.7%, after peaking in July 2006 at $230,900. In February, existing homes sales increased 4.4%, and the median home price advanced 2.4%. The ratio of monthly sales to the inventory of homes for sale was 9.5 months, versus 5 months in a healthy market. However, 45% of the sales in February were foreclosures, and that proportion will remain high in coming months. Since foreclosed sales represent forced selling, the persistently high level of foreclosures will continue to push home prices lower. As home prices fall another 5% to 10% or more, more home owners will realize that their mortgage exceeds the value of their home. An increasing number are simply choosing to walk away, since they have nothing to lose.

According to RealtyTrac, job losses result in a home foreclosure 10% to 15% of the time. If job losses narrow from the monthly average of 670,000 in the first quarter to 325,000, almost 3 million more jobs will be lost before year end. That will translate into another 300,000-450,000 foreclosures, and an unemployment rate of almost 11%. But what if that estimate of job losses is too optimistic?

New research by the Federal Reserve and Boston University of credit spreads of 900 non-financial companies from 1990-2008 predicted changes in the economy 'phenomenally' well. Based on their initial research on low to medium risk corporate bonds with more than 15 years to maturity, the researchers went back to 1973 and found the analysis still worked well. With the massive widening of corporate bond spreads last fall, the researcher's model predicts the economy will lose another 7.8 million jobs by the end of 2009, and industrial production will fall another 17%. In the spirit of optimism, let's assume this 'phenomenal' model is off by 35%, due to the extreme nature of this credit crisis. That still results in another 5.1 million lost jobs, and an 11% drop in industrial production. In that scenario, the unemployment rate climbs to near 12.5%, the underemployment rate breaches 20%, and another 500,000-750,000 foreclosures result.

The International Monetary Fund (IMF) now estimates the U.S., European, and Japanese financial sectors face losses of $4.1 trillion. Banks are confronting losses of $2.5 trillion, insurers $300 billion, and other financial institutions $1.3 trillion. To date, the banking sector has written down $1 trillion of expected losses. The IMF estimates that U.S. and European banks need to raise $875 billion in equity by next year to return to pre-crisis levels.

Over the last week a number of banks have reported first quarter earnings, which was a pleasant surprise. Citigroup said it made $1.6 billion. One of the ways Citigroup achieved this gain was booking a profit of $2.7 billion on the decline in Citi's (C) own debt. Say what? Under accounting rules, Citi was allowed to book a one-time gain equivalent to the decline in its bonds because, in theory, it could buy back its debt cheaply and save $2.7 billion over time. Of course, Citi didn't actually do that. Even though more consumer loans went bad in the first quarter, Citi reduced its loan loss reserve from $3.4 billion in the fourth quarter to $2.1 billion in the first quarter, thereby picking up another $1.3 billion of 'earnings'. And the recent change in mark to market accounting enabled Citi to book an additional $413 million in 'profit' on impaired assets. Without these one-time adjustments, Citi's $1.6 billion in first quarter profit becomes a $2.8 billion loss.

According to a Wall Street Journal analysis of Treasury Department data, the 19 banks that received tax payer funds made or refinanced 23% less in new loans in February versus last October. Why lend money when all you've got to do is make a few adjustments and make even more money.

Between 2000 and 2008, the major credit card companies increased the number of credit cards issued to small businesses from 5 million to 29 million. During that period, many small business owners increasingly relied on their cards to provide short term financing for their business. Spending on small business credit cards increased from $70.4 billion in 2000, to $296.3 billion, according to the Nilson Report. Over the last 15 months, business bankruptcy filings have risen faster than consumer bankruptcies, with the average charge-off rising to $11,000 from $7,000, according to Equifax, Inc. In response, the card issuers have been aggressively scaling back, and have reduced available credit lines by almost $500 billion. Just another example of how the availability of credit to the economy is evaporating, despite all the Fed's efforts.

Industrial production fell 1.5% in March, and is down 12.8% from a year ago. Capacity utilization fell to 69.3%, the lowest since records began in 1967. As I discussed in detail in January, excess capacity is a powerful dynamic. Companies are forced to reduce or eliminate budgeted investments in new equipment, compete for every dollar of revenue, even if it means accepting thinner profit margins, and reduce costs through job cuts. The amount of excess capacity that has been created by the depth of this economic contraction is unprecedented. What most inflation bugs and investors fail to understand is how long it will take to work off the current over hang of excess capacity. If the output gap grows from the current 7% to 10% next year, Goldman Sachs estimates it could be 2015 before all the excess capacity is used up, and that's if GDP grows 4.75% per year! Ironically, one of the reasons the economy is not likely to grow that fast is that business investment will be weaker than in prior business cycles. With so much excess capacity, businesses won't need to materially increase business investment for the next 2 or 3 years.

The economy needs to create 125,000 jobs each month, just to absorb the number of new entrants into the labor market. If job growth were to average 325,000 per month in coming years, it would still take four years to replace all the jobs lost in this recession. With so much excess labor capacity, wage growth will be weak for the next few years, which will make it harder for consumers to increase savings and spending. The combination of less credit availability, weaker business investment and consumer spending will be headwinds whenever the economy emerges from this recession.

The United States is mired in the deepest cyclical contraction since at least World War II, and arguably the depression. Falling home prices led us into this crisis, and home prices are still falling. The financial crisis in 2008 has become the economic crisis in 2009, as more than 2 million jobs were lost in just the first quarter, with another 3 to 5 million likely before year end. With the unemployment rate headed over 10%, and maybe up to 12% next year, the default rate on every type of consumer credit – (prime mortgages, Alt-A mortgages, Option Arm mortgages, sub-prime mortgages, home equity lines, credit cards, auto loans, student loans) – is headed much higher. Commercial real estate values are plunging, and corporate default rates are set to soar. Although every bank will 'pass' the government's stress test, some banks will fail the real world stress test, and need billions more in capital. Sooner or later, the Treasury Department will likely have to go hat in hand asking for more money from Congress for some of the banks. For the first time since World War II, the global economy will contract in 2009, so there aren't many places to hide. Although it is welcome to see a few 'green shoots', in this case, those green shoots are unlikely to yield a bountiful harvest in 2010.

In addition to the daunting cyclical problems challenging the economy, there are a number of significant secular issues I've discussed before that will make it even more difficult for a self sustaining recovery to develop in 2010. Between 1982 and 2007, the amount of Total debt grew from $1.60 to $3.53 for each $1.00 of GDP. This was made possible as the cost of money fell from 15% to 20% in 1982 to the generational lows of the last few years. As interest rates fell, consumers were able to take on more debt, without their monthly payments increasing very much.

Household debt has increased from $.44 in 1982 to $.98 for each dollar of GDP in 2007. However, there is no more relief coming from lower rates, so consumers are going to have to pay for their debt from income. From the mid 1990's until 2007, most consumers had the luxury of believing that their homes and 401Ks would provide most of what they would need for their retirement. The saving rate fell from over 8% 15 years ago to near 0% in 2007. The last 18 months has convinced them they need to increase their savings. The saving rate has rebounded to near 4% in the last six months, which is one reason why the economy has been so weak. As debt levels increased over the last 25 years, GDP was boosted as consumer's bought cars, bigger homes, second homes, went on nice vacations, and basically lived the good life. However, since 1966, each dollar of additional debt has given the economy less of a boost. In 1966, $1 dollar of debt boosted GDP by $.93. But by 2007, $1 dollar of debt lifted GDP by less than $.20.

The message from these facts is fairly clear. Debt levels are high, and any increase in interest rates will impose a bigger burden on the economy and quickly stunt growth. Consumer debt is already so high and interest rates are so low that it will be difficult for consumers to add debt. This means economic growth will be far weaker than the debt induced growth of the last 25 years. As consumers increase their savings, GDP will be lowered by .70% for each 1% consumers increase their saving, since consumer spending represents almost 70% of GDP. In addition, the banking system remains crippled. Lending standards are high and are not coming down with the economy remaining weak. The need for additional capital will lower future lending by several trillion dollars, as banks work to repair their balance sheets and lower their leverage ratios from 30 to the low teens. The securitization markets provide more credit than the banking system, but they remain on life support. Credit availability will remain constrained well into 2010, which represents a headwind than will mute some of the lift from fiscal stimulus.

The diminishing boost given to GDP from each additional $1.00 of debt since 1966 strongly suggests that adding more debt will not return the economy to prosperity. I am reminded of a movie from the 1950's, The High and the Mighty. It starred John Wayne and Robert Stack and was about an airline flight from Honolulu to San Francisco. During the flight, one of the engines fails, but they are past the point of no return, so they must try to make it to San Francisco. Over the last 60 years, the United States has used a combination of fiscal stimulus and monetary policy to soften each recession and spur the subsequent recovery, with a fair amount of apparent success. From 1982 until 2007, the U.S. only experienced two shallow recessions that each lasted just 8 months. This stretch of 25 years may be the best 25 years in our economic history. But much of this prosperity was bought with debt, as the ratio of debt to GDP rose from $1.60 to $3.50 for each $1.00 of GDP. Sometime in the last 25 years, we passed the point of no return. Unfortunately, Hollywood won't get to write the script on how this ends.

Comments

[Fred Voetsch:]

I read this article on John Mauldin's newsletter the other day and it offered some excellent data. It was perhaps the best summary I have seen recently of what we are facing, economically speaking.

Just as in 2007 it was possible to see what was coming and a smart investor was not swayed by a rising market. The government's "Atlas Shrugged" handling of this situation hs assured that the economy will at best struggle for years to come and may never be the same.

Will the market go up tomorrw or next week? Perhaps, but the real question is this: what is the real value of the stock market and the stocks you wish to invest in? Panic buying or selling only creates opportunity and only by staying unemotional about your investing will you make the right decision.

I suggest that we all start with the very basic point of data used to evaluate stocks: earnings.

online.wsj.com/mdc/pub...

www2.standardandpoors....

www.bullandbearwise.co...

It appears that we have the following P/E ratios for the major stock indexes as of May 6, 2009:

Dow Industrial 36.32 P/E
Dow Transportation 54.51 P/E
Dow Utility 10.67 P/E
Nasdaq Composite 54 P/E
Russell 2000 47.97 P/E
S&P 500 58 P/E

May 06 02:41 PM

[Dave Wrixon:]

To be fair to Ben, The Point of No-Return was passed a long time ago. Perhaps as others have said here the only game in town is to absorb the shock to mitigate the damage. A lot of companies are going to fold. Perhaps, however, some that didn't need to fold could yet be be save. However, this must not be done by throwing the entire economy into an even more aggressive downward spiral. If the US had taken the hit back into 2001 perhaps we would be in this mess. If it refuses to take the hit this time around the next collapse is likely to come much sooner and be several times bigger. The next one might simply not be survivable. My advise would be to deleverage whilst there is still a chance of salvaging something from the mess.


On May 06 01:03 PM basehitz wrote:

> Bjarne Jensen's post above sums up my concerns so I won't repeat.
> But I will add, if we do develop our total scope of natural resources
> while aggressively moving to renewable fuels, that would be massively
> better than borrowing money from China to buy oil from OPEC while
> our resources remain buried.
>
> John, excellent analysis. Thank you. BTW, you will be appearing on
> CNBC soon to present this won't you. I request you expand your analysis
> to include what scenarios could happen if China decides to quit buying
> our junk (I mean AAA) debt. The race of Bazooka Ben printing money
> vs the race of dollar devaluation while energy skyrockets. "Point
> of no return" may be more real than many can bear to consider. Speaking
> of bears. . .

May 06 02:45 PM

[johnbee:]

I am from the UK also. It needs a wealthy investor or group to take a civil case against bank malfeasance as the Government and its cronies will not prosecute them, since to do so can so nearly implicate Government departments and ministries too close to home. So the police and the judiciary are no doubt to be actively discouraged from any action on their part on the basis that they would upset the applecart and jeopardise the banks' credibility with the public- on the presumed notion that they still have any!
Its as clear as day that criminal negligence at least has taken place in the banks as why would they have been in such a rush to take their bonuses and disappear? But their defence will be the same as followers of the 3rd Reich- we were just following orders!


On May 06 09:20 AM bozzy wrote:

> Thank you for a luminous and truly excellent piece of analysis. And
> all the while the market says let's have a party Q1 2010???
>
> I don't think so, and here in the UK, historically our problems have
> followed where the US leads, so talk of recovery in the absence of
> fundamental support seems very premature indeed. The PNR (point of
> no return) analogy feels very apt: for aviators, it is mostly calculated
> for long flights over dangerous terrain with nowhere to land - eg
> water. Right now, the quantitative easing measures and banking bailouts
> have resulted in very little lubrication for the credit markets,
> and here, as in the USA, it would appear that there is little choice
> but to carry on in hope alone.
>
> If that is so, the pain is going to get a lot worse yet.
>
> With Joe public's sons and daughters about to pick up a very large
> tax bill, how strange that with statute law available to establish
> possible culpability and personal liability of directors for transactions
> during the 6 months preceding insolvency, not one of the bailed out
> bank directors in the UK has even been investigated on these grounds,
> yet official and public condemnation abounds, and the so-called regulator
> says it is determined to hang tougher and tougher.
>
> So much for the end of cronyism in the UK.

May 06 03:09 PM

[PROXIMO:]

Enjoyed the article. Obviously much effort and hard work was expended to put this together. Can't remember this many positive comments about a single article on SA.

May 06 03:13 PM

[Randy Kirk:]

An interesting aspect of the Morgan Stanley chart showing total debt as a percentage of gdp is that most of the debt increase from the 1950's to current occured in three sectors: household, financial and GSE. Most of this (I believe) should be in mortgages.

GSE debt -- mainly Fannie and Freddie, includes the bonds on the liability side of the GSE's balance sheets. I can see Freddie had approx. $800Bn of bond debt in 2007 (2008 info unavailable) according to their 2007 10-k. These bonds were used to fund purchases of (conforming) mortgages.

Consumer debt tends to be highly mortgage based, as houses are typically the largest component of most families net worth.

Financial firms will include commercial banks which lend heavily to real estate.

What is interesting is that GDP is calculated by the BEA mainly by summing up salaries, and then backing into GDP by using the formula Consumption = salaries - saving, for use in the formula for GDP = C+I+G+ Net Exports. (on this point, see the original discussion of GDP measurement by Nobel laureates Richard Stone and Simon Kuznets) nobelprize.org/nobel_p...

So this shows that not even adjusting for median (not average) salary, credit risk is rising for the sectors that took on the most debt., -- this is more clarification on the most obvious factor that the overall national debt appears to be rising. As the increase in debt is based on the value of land, plus salaries, the crisis appears to be exacerbated by a) declines in land values and/or b) declines in average and median incomes. Conversely, the crisis should appear to be on the mend when a) land values stabilize and start to appreciate and/or b) median and average salaries start to stabilize and appreciate.

May 06 03:29 PM

[Gem Hudson:]

The money that does not pay off the debt buy none of their gold and the Chinese keep on loaning out the loans to keep the dollar value on the foreign dollar index exchange rate up or President Hu can uncouples the dollar as the world reserve currency and buys all the gold he wants in his own oriental reserve currency.

The day the Chinese can back their wane on their gold stander. The day the Chinese will no longer buy out the debt and die hard, losers.

May 06 03:42 PM

[TA:]

I love these articles and comments

This rally makes no sense so I will just explain how it can't be and get mad.

Or you could stfu and just make money from it.
Your choice, It's pretty obvious what most of the readers here are doing.

May 06 05:04 PM

[Jason Rines...:]

Bingo. And a government attempting to replace lost capital spent on previous consumption through manipulation becomes very, very fickle. Like a woman's perrogative to change her mind.
>
> Dow Industrial 36.32 P/E
> Dow Transportation 54.51 P/E
> Dow Utility 10.67 P/E
> Nasdaq Composite 54 P/E
> Russell 2000 47.97 P/E
> S&P 500 58 P/E

May 06 05:20 PM

[Glen L.:]

Mr. Lounsbury,

"It is not necessarily the magnitude of a change as much as the speed of the change. If a major change occurs over one or two decades (or longer), individuals and businesses have a chance of adapting. If they occur in a matter of months, there can be mass extinctions."

You obviously are putting a lot of faith in the Fed and Treasury to right the sinking ship, with some trepidation that they may not get it right, but my point is that they're the ones that blew holes in the hull in the first place. They did this by creating artificial booms called the dot com and housing bubbles, which were inflated by the Fed setting irrationally low interest rates, first to help out Bill Clinton, then George W. Bush, to get the country out of relatively minor recessions. A massive malinvestment environment ensued, which could not have happened if interest rates had remained higher and the recessions were allowed to wipe out the previous malinvestments.

There are many, many bright people on SA who are just uneducated in proper economics; that's the only thing I can see that explains how those people can think that inflating another even more gigantic bubble and hoping to resume the debt-ridden, consumption-driven lifestyles of the past will somehow get us out of this, when those actions are the very things that got us here in the first place. Like many, I can't think of a better analogy than the addict shooting up more and more happy juice to forestall the inevitable crash, but that crash will come; and when it does, if the inflationistas push it too far, it could be fatal.

The depression of 1923 (they were all called depressions at one time) was sharp and painful, with massive job losses, bank failures, and the rest of the devil's brew. But Warren G. Harding (one of the most unjustly maligned Presidents in history) and the nascent Fed did virtually nothing about it, and within 18 months it was all over. Of course, Bernanke and his Treasury/Goldman stooges would like us to believe that "this time it's different" and the crisis is too big to do nothing, but it's just a lie aimed at acquiring maximum power AND hiding their previous stupid mistakes. If it's not, why does the Fed operate in complete secrecy, and why do they oppose an independent audit?

Ron Paul's bill to audit the Fed now has something like 140 co-sponsors, from both sides of the aisle. I urge all SA readers to get familiar with this legislation and get behind it. Then some day soon we may rid ourselves of the central banking cartel that has come ever so close to destroying the dollar and the entire American economy.

Nothing is too big to fail.

May 06 05:51 PM

[Manifestor:]

Seeing the list of commentors and their comments (majority) gives me a feeling it is preaching to a choir.
The overall analysis while detailed, is quite incomplete and very subjective in places not backed by enough data. The take away from this article will be different for different people for the following reasons:
1. Some would consider this as stale news since most of the analysis is based on data till the end of March. We are now in May and the April data and the market movements since mid March have been different.
2. A key factor not discussed at any length is consumer and business confidence and confidence in where the country is headed. These could do wonders to jump start the economy as the last couple of months has shown.
3. The essay extrapolates future only based on past data and current debts. Doesn't take into account considerations such as innovation, new technology, improved efficiencies, new and emerging middle class export markets in the rest of the world, geo-politics and more.
4. The world markets, emerging markets in particular, have been on a tear lately. Not mentioned in this article.

May 06 05:52 PM

[History Buf...:]

A very good question, why? My quess is, anyone who has the answers, isn't talking.

We accept government manipulation in all kinds of ways. But the thought of the government printing up money and using it to prop up a stock market rally seems like a line has crossed (if that is indeed what is going on). Call me a worry-wart, but I can't see this ending well.

Somehow, I don't see this is being the "invisible hand" that Smith had in mind. But, as Galileo is reputed to have said under his breath in front of the inquisition (in reference to his observation that the earth in fact did move about the sun) "Nonetheless, it moves".

It does move, but we know not why or how.


On May 06 02:07 PM AndrewBaker wrote:

> So well written and with such clearly presented and easily understand
> data, and supported by so many people, yet markets continue to go
> up, especially financials, as if we really are coming out of this
> recession. How can this be, that despite such obvious signs of worse
> to come, so many are prepared to not only accept the disinformation
> we are being fed by various people and agencies, but also support
> it with their investment? How much of this buying is being done by
> individuals and how much by mutual fund managers who just want to
> get their % take? And how much of our bail-out tax dollar is being
> pumped into the markets to make things look far better than they
> are?

May 06 06:10 PM

[mkt-student:]

Well and thoroughly said JL.

great line
"Sometime in the last 25 years, we passed the point of no return. "

As evidence of that postulation I would offer this note from Bloomberg's bond summary yesterday;

.....www.bloomberg.com/apps...

......Trading volume has fallen even as supply has increased. Trading in Treasuries this year has averaged $175 billion a day, according to ICAP Plc, the world’s largest inter-dealer broker. Not a single day has seen $300 billion in Treasuries change hands this year, compared with last year’s daily average of $301.8 billion. The 200-day moving average, used by some technical analysts to judge longer-term trends, has fallen to $221.4 billion.
“Trading volumes have been on the decline since last fall despite a huge surge in issuance,” wrote UBS Securities LLC strategists led by Chris Ahrens. “It may result in supply being distributed in larger blocks requiring greater price discounts.”.............

I speculate that the tape is telling us that its time to "exit stage left"

May 06 06:11 PM

[minieconomics:]

I can see the light

I have been in the wilderness, a lone spirit thinking dark thoughts, thinking that all those around me were heading blindly into an economic chasm. I was isolated and sad. Whenever I suggested that something was wrong, I was ridiculed or ignored. I could not share their economic bliss when the television and newspapers showed that their houses and shares were going up in value.
All I could see was the pain ahead. I couldn’t share in the unabated enthusiasm for their new construction projects or enjoy their fast new cars. Yes, I did enjoy the odd weekend of sailing on their beautiful yacht – but who wouldn’t?
They wore smart designer clothes but worked hard, very long hours, and that showed on their faces and in their drinking habits. They were always in a rush and didn’t see much of their children who were at boarding school but the boys were doing well and making good contacts for the future. The whole family were good at skiing due to their annual winter holidays at Jackson Hole. They had everything planned, including their retirement in their second house on the beachfront. They were the perfect successful family. Yes they were in debt, but that was short term, they were worth substantially more and their bank manager was a friend who sorted out any short term problems with a bit more refinancing.
I could have been like them. Why did I stop myself from joining in the jamboree?
I am happy now. I am one of them. Life is wonderful, the future is rosy.
Could I have another of those cigarettes? Good stuff eh? I can see why they are going to legalise it, and it will reduce the fiscal deficit as well!!!! When are they going to be ready with that ‘animal farm’ vaccine? I can’t wait, I am sure that there will be a ‘feel good factor’ mixed in with it.
Sing with me, ‘Don’t worry. Be ee happy!’

By the way, what happened to them?

May 06 07:45 PM

[altaman:]

This administration's frantic desire just do something quickly, and a supine and ignorant media, has lead to the worst of all worlds - a transfer of massive debt and risk to taxpayers without actually fixing the economy's problems. This will put a drag on our economy for generations. Eventually the Treasury and the Fed will shoot their wads, or the taxpayers will rebel, and the Zepplin will crash and burn. We may see UAW workers being paid in unsold cars or repossessed homes before this fool is done.

May 06 09:25 PM

[Asitoughtobe:]

The information in the article covers a wide variety of topics.

I'd like to determine two things:

Will people adjust their lifestyles and begin to live within their means?

And where America's future GDP lies based on the outcome the previous question?

May 06 10:37 PM

[geewow:]

Well written and thorough analysis. Thanks!

eye-on-washington.blog...

May 06 11:05 PM

[axelrod608:]

John - two things I love about your articles are their substance and clarity and the way you engage with the commentors who respopnd to your articles. Economists have a serious problem, in that their theories at times simply don't have any correlation with reality. Based on what has happened in the past year, I fail to find ANY economic theory that has substantial support.

I started feeling over a year ago that economic theory would "hit the wall" ( old racing analogy) in the next few years and the old maxims on which federal economic and monetary policy would be outed.

This is not your grandfather's or you father's economy. And I suspect Congress and the new admin don't really understand that

Regulatory inaction effectively neutered any protection the public had. We are awash in a flood of absolutely uncontrolled derivatives. And we will remain at serious risk until derivatives are vetted, approved, licensed and insured. You cannot have highly leveraged "investments" that are uninsured in a functional economy.

This opinion is seriously opposed by the folks who would have the ignorant populace believe all is well and the financial institutions are being run by den mothers. Uh, say it isn't so, binky.

There's a lot of old economic theory that just simply doesn't fit the current mold. . "This time it's different" - one part of me says no way. The other part says "this doesn't look like .... " I fear the economists bank has been broken.

This doesn't look like what they're talking about.

May 06 11:59 PM

[Ferdinand E...:]

So Mr Jensen believes that half of the US population is a drain rather than a gain. What he primarily means by that is the half that voted for Obama instead of the man who is in favor of a hundred years of war in Afghanistan in order to win a war that was actually won five years ago. Well Mr Jensen, when the next election takes place I am going to put my brilliant shoulder to the wheel and do everything I can to convince American voters in my near-environment that they should take my advice about who should be president of the US instead of turning to obsessive bloggers for advice and comfort.

May 07 01:42 AM

[montyman:]

I do find it a strange coincidence that the Taliban have suddenly and out-of-the-blue scored advances in Pakistan, just at the same time that markets look set up for some big downside pain. Hmmmmm?


On May 06 12:44 PM carey_jim wrote:

> Well-reasoned, excellent presentation.
>
> Other aspects of our American malaise might be even more important,
> such as our seeming need to fight wars of expansion.
>
> America was founded with a violent revolution, perpetuated with a
> civil war and expanded with imperialistic wars against Spain and
> Mexico.
>
> We rose to world economic dominance after victories in World War
> I and II and then defeated the Soviet Union, the only rival left
> on the world stage, in the cold war that lasted for several generations.
>
>
> One of Mohammad's favorite sayings was "Happiness is found under
> the shadow of swords" so maybe it's more than simple chance that
> America finds itself engaged in a life and death struggle with Islam.
>
>

May 07 03:04 AM

[montyman:]

WTF is this poetry or something?


On May 06 03:42 PM Gem Hudson wrote:

> The money that does not pay off the debt buy none of their gold and
> the Chinese keep on loaning out the loans to keep the dollar value
> on the foreign dollar index exchange rate up or President Hu can
> uncouples the dollar as the world reserve currency and buys all the
> gold he wants in his own oriental reserve currency.
>
> The day the Chinese can back their wane on their gold stander. The
> day the Chinese will no longer buy out the debt and die hard, losers.

May 07 03:21 AM