Worse Than The Illness?

Is The Medicine Worse Than The Illness?

By James Grant | 20 December 2008

The world ran out of trust in 2008— but there is no shortage of money because the Fed is 'printing' like mad. It's the wrong approach, with potentially dire consequences, says James Grant.

It is a sorry place at which we Americans find ourselves this none-too-festive holiday season. The biggest names on Wall Street have gone to their rewards or into partnership with the U.S. Treasury. Foreigners stare wide-eyed from across the waters. A $50 billion Ponzi scheme (baited with, of all things in this age of excess, the promise of low, spuriously predictable returns)? Interest rates over which tiny Japanese rates fairly tower? Regulatory policy seemingly set by a weather vane? A Federal Reserve that can't make up its mind: Is it in the business of central banking or of central planning? And to think— our disappointed foreign friends mutter— all of these enormities taking place under a Republican administration.

Trust itself entered a bear market in 2008, complementing and perhaps surpassing the selloffs in stocks, mortgages and commodities. Never to be confused with angels, we humans seem to outdo ourselves when money is on the line. So it is that Bernard Madoff, supposed pillar of the community, stands accused of perpetrating one of the greatest hoaxes since John Law discovered the inflationary possibilities of paper money in the early 18th century.

Bundles of freshly printed bills at the Treasury Department.

Barely nudging Mr. Madoff out of the top of the news was the Federal Reserve's announcement last Tuesday that it intends to debase its own paper 'money'. The year just ending has been a time of confusion as much as it has been of loss. But here, at least, was the bright beam of clarity. Specifically, the Fed pledged to print dollars in unlimited volume and to trim its funds rate, if necessary, all the way to zero. Nor would it rest on its laurels even at an interest rate low enough to drive the creditor class back to work. It would, on the contrary, "continue to consider ways of using its balance sheet to further support credit markets and economic activity."

Wall Street that day did handsprings. Even government securities prices raced higher, as if, somehow, Treasury bonds were not denominated in the currency with which the Fed had announced its intention to paper the face of the earth. Economic commentators praised the central bank's determination to fight deflation— that is, to reinstate inflation. All hands, including President-elect Obama, seemed to agree that wholesale money-printing was the answer to the nation's prayers.

One market, only, registered a protest. The Fed's declaration of inflationary intent knocked the dollar for a loop against gold and foreign currencies. In many different languages and from many time zones came the question, "Tell me, again, now that the dollar yields so little, why do we own it?"

It was on Oct. 6, 1979, that then-Fed Chairman Paul A. Volcker vowed to print less money to bring down inflation. So doing, he closed one monetary era and opened another. With Tuesday's promise to print much more money, the Federal Reserve of Ben S. Bernanke has opened its own new era. Whether Mr. Bernanke's policy of debasement will lead to as happy an outcome as that which crowned the Volcker anti-inflation initiative is, however, doubtful. Whatever the road to riches might be paved with, it isn't little green pieces of paper stamped "legal tender."

Fed Chairman Ben Bernanke appears before Congress in Oct.

Our troubles, over which we will certainly prevail, stem from a basic contradiction. The dollar is the world's currency, yet the Fed is America's central bank. Mr. Bernanke's remit is to promote low inflation, high employment and solvent finance— in the 50 states. He wishes the Chinese well, of course, and the French and the Singaporeans and all the rest besides, but they don't pay his salary.

They do, however, buy the U.S. Treasury's bonds, which frames the emerging American dilemma. If the Fed is going to create boatloads of depreciating, non-yielding dollar bills, who will absorb them? Who will finance the Obama administration's looming titanic fiscal deficits? Who will finance America's annual surplus of consumption over production (after 25 more or less continuous years, almost a national trait)? Inflation is a kind of governmentally sanctioned white-collar crime. Every crime needs a dupe. Now that the Fed has announced its plan to deceive, where will it find its victims?

Mr. Bernanke has good reason to worry about the economy. We all do. In the boom, a superabundance of mispriced debt led countless people down innumerable blind investment alleys. E-Z credit financed bubbles in real estate, commodities, mortgage-backed securities and a myriad of other assets.

It punished saving and encouraged speculation. Imagine a man at the top of a stepladder. He is up on his toes reaching for something. Call that something "yield." Call the stepladder "leverage." Now kick the ladder away. The man falls, pieces of debt crashing to the floor around him.

The Fed, watching this preventable accident unfold, rushes to the scene too late. Not only did Bernanke et al. not see it coming, but they actually egged the man higher. You will recall the ultra-low interest rates of the early 2000s. The Fed imposed them to 'speed recovery' from an earlier accident, this one involving a man up on a stepladder reaching for technology stocks.

A money trader reacts to the falling price of the dollar on Dec. 12.

The underlying cause of these mishaps is the dollar and the central bank that manipulates it. In ages past, it was so simple. A central banker had one job only, and that was to assure that the currency under his care was exchangeable into gold at the lawfully stipulated rate. It was his office to make the public indifferent between currency or gold.

In a crisis, the banker's job description expanded to permit emergency lending against good collateral at a high rate of interest. But no self-respecting central banker did much more. Certainly, none arrogated to himself the job of steering the economy by fixing an interest rate. None, I believe, had an economist on the payroll.

None facilitated deficit spending by buying up his government's bonds. None cared about the 'average level of prices', which rose in wartime and sank in peacetime. It sank in peacetime because technological progress and the opening of new regions to agricultural production made merchandise and commodities cheaper and more abundant.

Not everyone agreed that these arrangements were heaven-sent. In comparison to the rigor of the gold standard, paper money seemed, to many, an intelligent and forgiving alternative. In 1878, a committee of the House of Representatives was formed to investigate the causes of the suffering of working people in the depression that was five years old and counting. Not a few witnesses pleaded for the creation of more greenbacks. They asked that the government not go through with its plan to return to the gold standard in 1879. But the nation did return to gold— it had financed the Civil War with paper money— and the depression ended in the very same year.

Gold is a hard master, and a capricious one, too, insofar as growth in the world's monetary base depends on the enterprise of mining engineers. But, as we have seen lately, there is no caprice like the caprice of sleep-deprived Mandarins improvising a monetary solution to a credit crisis (or, for that matter, of fully rested Mandarins setting interest rates by the lights of their econometric models). The times were hard in the 1870s and, for that matter, again in the 1890s.

But Americans repeatedly spurned the Populist cries for a dollar you didn't have to dig out of the ground but could rather print up by the job lot. "If the Government can create money," as a hard-money propagandist put it in an 1892 broadside entitled "Cheap Money," "why should not it create all that everybody wants? Why should anybody work for a living?" And— in a most prescient rhetorical question— he went on to ask, "Why should we have any limit put to the volume of our currency?"

A couple of panics later, the Federal Reserve came along— the year was 1913. Promoters of the legislation to establish America's new central bank protested that they wanted no soft currency. The dollar would continue to be exchangeable into gold at the customary rate of $20.67 an ounce. But, they added, under the Fed's 'enlightened' stewardship, the currency would become "expansive." Accordion-fashion, the number of dollars in circulation would 'expand or contract' according to 'the needs of' commerce and agriculture.

Elihu Root warned about 'easy money' in the early 1900s.

Elihu Root, Republican senator from New York, thought he smelled a rat. Anticipating the credit inflations of the future and recalling the disturbances of the past, Mr. Root attacked the bill in this fashion:

"Little by little, business is enlarged with easy money. With the exhaustless reservoir of the Government of the United States furnishing easy money, the sales increase, the businesses enlarge, more new enterprises are started, the spirit of optimism pervades the community. "Bankers are not free from it," Mr. Root went on. "They are human. The members of the Federal Reserve board will not be free of it. They are human....Everyone is making money. Everyone is growing rich. It goes up and up, the margin between costs and sales continually growing smaller as a result of the operation of inevitable laws, until finally someone whose judgment was bad, someone whose capacity for business was small, breaks; and as he falls he hits the next brick in the row, and then another, and then another, and down comes the whole structure. "That, sir," Mr. Root concluded, "is no dream. That is the history of every movement of inflation since the world's business began, and it is the history of many a period in our own country. That is what happened to greater or less degree before the panic of 1837, of 1857, of 1873, of 1893 and of 1907. The precise formula which the students of economic movements have evolved to describe the reason for the crash following the universal process is that when credit exceeds the legitimate demands of the country the currency becomes suspected and gold leaves the country."

[[But, withall, we have not had a really serious inflation/deflation, or economic crash, since the Great Depression— the end of "hard" currency— not even since the end of any ties to "hard" currency and the beginning of the era of unlimited "fiat" money in 1971: normxxx]]

Little did Mr. Root suspect that the dollar would lose its gold backing altogether— that, starting in 1971, there would be nothing behind it more than the 'good intentions' of the U.S. government and (somewhat more substantively) the demonstrated strength of the U.S. economy. Still less could he have guessed that the world would nonetheless fall in love with that uncollateralized piece of paper or— even more astoundingly— that the United States would enjoy so great a reservoir of good will that it would be allowed to borrow its way to a net international investment position of minus $2.44 trillion ($17.64 trillion of foreign assets held by Americans vs. $20.08 trillion of American assets held by foreigners). "It goes up and up," Mr. Root said of the inflationary cycle, but just how high he could not have dreamt.

Knowledge of the precepts of classical central banking prepared no one to understand, much less to anticipate, the Fed's conduct in this credit crackup. The central bank is lending freely, all right, but not at the stipulated "high" interest rate. As a matter of fact, it is starting to lend at a rate below which there is no positive rate. The gold standard was objective.

Modern monetary management is subjective (under Alan Greenspan, it was intuitive). The gold standard was rules-based. The 21st century Fed goes with what works— or seems to work [[at least for now, and the devil take the next guy up! : normxxx]] What it hopes is going to work for the fellow who fell off the stepladder is more debt and more dollars.

Just how much of each can be found every Thursday evening on the Fed's own Web site. Open up form H4.1 and prepare to be amazed. Since Labor Day, the Fed's assets have zoomed to $2.31 trillion from $905.7 billion. And what is the significance of this stunning rate of asset growth? Simply this: The Fed pays for its assets with freshly made dollars. It conjures them into existence on a computer; "printing" is a figure of speech. [[An increasingly "quaint" figure of speech; there's probably not enough paper and printer's ink to produce the actual!: normxxx]]

In this crisis, the Fed's assets have grown much faster than its capital. The truth is that the Federal Reserve is itself a highly leveraged financial institution. The flagship branch of the 12-bank system, the Federal Reserve Bank of New York, shows assets of $1.3 trillion and capital of just $12.2 billion. Its leverage ratio, a mere 0.9%, is less than one-third of that prescribed for banks in the private sector.

Such a thin film of protection would present no special risk if the bank managed by Timothy F. Geithner, the Treasury secretary-designate, owned only short-dated Treasurys. However, the mystery meat acquired from Bear Stearns and AIG foots to $66.6 billion. A writedown of just 18.3% in the value of those risky portfolios would erase the New York Fed's capital account.

In congressional testimony eight years ago, Laurence Meyer, then a Fed governor, tried to allay any such concerns (which then must have seemed remote, indeed). "Creditors of central banks...are at no risk of a loss because the central bank can always create additional currency to meet any obligation denominated in that currency," he soothingly reminded his listeners. Yes, today's policy makers allow, there are risks to "creating" a trillion or so of new currency every few months, but that is tomorrow's worry. On today's agenda is a deflationary abyss. Frostbite victims tend not to dwell on the perils of heatstroke.

But the seasons of finance are unpredictable. Prescience is rare enough in the private sector. It is almost unheard of in Washington. The credit troubles took the Fed unawares. So, likely, will the outbreak of the next inflation. Already the stars are aligned for a doozy.

Not only the Fed, but also the other leading central banks are frantically ramping up money production. Simultaneously, miners and oil producers are ramping down commodity production— as is, for instance, is Rio Tinto, the heavily encumbered mining giant, which the other day disclosed 14,000 layoffs and a $5 billion cutback in capital expenditure. Come the economic recovery, resource producers will certainly increase output. But it is far less certain that, once the cycle turns, the central banks will punctually tighten. [[And, in any case, certainly not dramatically. : normxxx]]

The public has been slow to anger in this costliest and scariest of post World War II financial crises. Wall Street and the debt ratings agencies have come in for well-deserved castigation. But pointing fingers rarely find the Federal Reserve, whose low, low interest rates helped to set house prices levitating in the first place.

After Mr. Bernanke gets a good night's sleep, he should be called to account for once again cutting interest rates at the expense of the long-suffering (and possibly hungry) savers. He should be asked to explain how the central-banking methods of the paper-dollar era represent any improvement, either in practice or theory, over the rigor, elegance, simplicity and predictability of the gold standard. He should be directed to read aloud the text of critique by Elihu Root and explain where, if at all, the old gentleman went wrong. Finally, he should be directed to put himself into the shoes of a foreign holder of U.S. dollars. "Tell us, Mr. Bernanke," a congressman might consider asking him, "if you had the choice, would you hold dollars? And may I remind you, Mr. Chairman, that you are under oath?"

James Grant, the editor of Grant's Interest Rate Observer, is the author most recently of "Mr. Market Miscalculates."

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Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A 'Minsky Meltdown'?

A Minsky Meltdown?

By John Bogle | 30 December 2008

An old story— perhaps apocryphal— tells of the tailor who made his living selling fine silk shirts to the wealthy wizards of Wall Street. When the stock market crashed in 1929, he delighted in their demise. But within a year, his own business, bereft of customers, itself went bankrupt.

The failure of our financial system, as this sad example makes clear, often resonates throughout our entire economy. Today, we already see the profound weakness in our financial sector finding its way into the rest of our economy. [[And, at breakneck speed! : normxxx]] It will be hard for many of our citizens, far less well-to-do than our moneymen and moneywomen, to bear. In 2006, the wealthiest 20 percent of wage earners in Manhattan made some $350,000 a year on average, nearly 40 times the $8,800-a-year income earned by the poorest 20 percent.

In my long career in finance, going way back to 1951, I've now witnessed 10 bear markets (defined as a decline in the stock market of 20 percent or more). The current bear market has been off by more than 50 percent, slightly larger than the 1973–1974 and 2000–2001 crashes. But this decline is the first that I can recall in which the distress of the financial markets so profoundly [[and so quickly: normxxx]] impacted the real economy of goods and services, of ordinary people, especially of those who had no real way to participate in the boom that led to the bust, but who are, nevertheless, now paying the penalty for the market's excesses. [[And, around the world! : normxxx]]

What we are increasingly seeing is the verification of "the financial instability hypothesis" put forth by the economist Hyman P. Minsky (1919–1996). In 1992, Minsky warned that "capitalist economies exhibit ... debt deflations which ... spin out of control ... [as] the economic system's reactions to a movement of the economy amplify the movement ... . Government interventions aimed to contain the deterioration [are often] inept in … historical crises."

Minsky concluded that over long periods of prosperity, the economy transits from financial structures that make for a stable system to ones that make for an unstable system— i.e., that "stability leads to instability," largely through what he described as hedging, speculation and Ponzi finance. In that sense, Minsky was a prophet of [several] of today's economic crises.

Another insight was also prophetic: "Institutional complexity [read: today's collateralized debt obligations and credit default swaps] may result in several layers of intermediation between the ultimate owners of the communities' wealth, and the [business and individual] units that control and operate the communities' wealth." This separation between ownership and control has now come to pass. In a mere half-century, we have moved from an ownership society (92 percent of all stocks owned by individuals; 8 percent by institutions) to an 'agency' society (24 percent and 76 percent, respectively), a change I've described as "a pathological mutation in capitalism".

How has this separation contributed to the recent crisis? First, because these new agents— institutional money managers advising mutual funds and retirement plans— have far too often placed their own financial interests ahead of the interests of fund owners and retirement plan beneficiaries, ignoring the interests of their own principals. And second, because these agents have departed from their traditional investment principles focused on the wisdom of long-term investing to a 'new' approach that relies on the folly of short-term speculation.

How great a departure does this change in investment principles represent? An enormous change, however rarely noted. Today, turnover of stocks in the United States, which ran in a range of 20 to 40 percent during my first 30 years in the mutual fund field, will come to more than 300 percent in 2008— something like 10 times as large. [[But in line with, though still greatly exceeding, that of 1929. See also, "The Inevitable Dénoument" by Alan M. Newman, editor, Crosscurrents: normxxx]]

Yet it is not Wall Street, but the ordinary citizens of the United States who will foot the bill. "The government," as always, has no money of its own. So it is paying the financial sector for its gross excesses with our money. We may pay for part of this bailout with higher taxes, but given our flawed political system, the cost is more likely to be extracted from future generations with dollars that buy less. Inflation is just another form of taxation, albeit one that is sharply regressive. [[In other words, as usual, those who benefitted least will bear the greatest burdon.: normxxx]]

As the woes of our financial system resonate through our economy, it seems crystal clear that our current recession will intensify— a "Minsky Meltdown" of significant proportions. While I believe that something more serious— obviously, a depression— is unlikely, we can't be sure whether our plummeting stock market: (a) has yet to adequately anticipate the depth of the economic downturn; (b) has already anticipated it; or (c) has anticipated something much worse than what is likely to transpire.

I'm inclined to believe that the answer is somewhere between (b) and (c). Why? Because the market value of U.S. stocks has tumbled by 50 percent— from $18 trillion to $9 trillion, and I just can't imagine that the value of American enterprise is $9 trillion lower than it was at the market high last October. Further, let's not forget that today's lower stock prices translate into stronger fundamentals underlying future returns:

• The dividend yield on the S&P 500— less than 2 percent in October 2007 and a skinny 1 percent in March 2000— is now 3.5 percent, a far larger contributor to future returns.


• The price-earnings multiple, 32 times at the 2000 market high, is now about 12 to 15 times (depending on whether we look at operating or reported earnings).


• The price of the S&P 500 Index is now about 1.8 times book value, a level not seen since 1990. (The price-book ratio reached the elevated level of 5.5 times in early 2000. [[for the significance of that, see "Valuing Wall Street: Protecting Wealth in Turbulent Markets" by Andrew Smithers and Stephen Wright: normxxx]])

As Benjamin Graham observed, in the short run, the market is a voting machine, but in the long run it is a weighing machine. Put another way, "The fundamental things apply as time goes by."

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Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Crisis Deepens; Asian Exports Plunge

For anyone who thinks the Credit Crisis has retired. The rest of the world seems now to be tanking worse than the US.

Crisis Deepens In Japan And China As Asian Exports Plunge
Japan's Exports Plunged 27% Last Month In The Steepest Fall For Half A Century.

By Ambrose Evans-Pritchard | 22 December 2008

The shock data came as the Japanese Cabinet Office warned that the world's second biggest economy is now deteriorating at an "exceptionally high pace". Shipments collapsed to almost all markets in North America, Europe, and Asia, following a pattern already set in recent days by South Korea, Taiwan, and China. Thailand on Monday said its exports fell 19% in Novermber. It is unclear to whether the violent drop is distorted by a "one-off" inventory shock as end companies slash stocks, or whether it is the start of a trade slump that threatens Asia's entire export strategy.

"We think this is very serious," said Stephen Jen, currency chief at Morgan Stanley. "These export surplus countries are super-leveraged to the West, and now we're seeing a multiplier effect (in reverse) as the intra-Asian trade model is stress-tested. What's incredible is that Japan has run a trade deficit for two months in a row despite the [huge] fall in oil prices. The next country to watch is going to be Germany," he said.

The Baltic Dry Index measuring freight rates for bulk goods has crashed by 94% since peaking in June. Container shipping for manufactured goods has been less volatile but that too has begun to buckle. Denmark's Maersk and China's COSCO have both cut container rates from Asia by a quarter.

Importers have been struggling to secure letters of credit, the lubricant of the trading system. Even large banks in Asia have had trouble obtaining dollars needed for shipping deals. Masaaki Shirakawa, the Bank of Japan's governor, said the central bank was preparing to buy corporate debt and commercial paper in an emergency move to unlock the credit market. It cut interest rates to 0.01% on Friday, tantamount to zero.

"It's an exceptional step," he conceded, insisting that the authorities were taking on private credit risk with great reluctance. The bank is boosting its purchase of governement bonds from ¥1.2 trillion to ¥1.4 trillion ($156bn) per month in a return to 'quantitative easing'. In China, the central bank cut rates for a fifth time since September to 5.31% and trimmed the reserve requirement for lenders. The Govenrmment is rushing through a $585bn fiscal stimulus package.

Beijing is alarmed by outbursts of civil unrest, both in the country's hinterland as 9m migrant workers return home after losing their jobs, and in the export hub of Guangdong where violence has been simmering for months. Some 3,600 toy factories have already closed this year. Premier Wen Jiabao said over the weekend that the key priority is to find jobs for migrants and some 6m fresh graduates— the two groups most feared as a political tinderbox.

"If you are worried, I am more worried than you," he told students. Japan's economy minister Kaoru Yosano said Tokyo is mulling a range of drastic measures to support the economy, including the outright purchase of equities held by banks in distress. "We're ready to do everything we can to break the cycle of deterioration in sentiment," he said.

The Cabinet Office warned that the surge in the yen against all major currencies was now tightening like a vise on Japan's economy. "The tempo of the economic downturn is getting substantially faster. What's worse is that there are many negative factors that can make a recession deeper and longer," it said.

The yen has appreciated by a third to ¥89 against the dollar since the credit crunch began. It has doubled in value against sterling. There has been a dramatic reversal of the "carry trade" as hedge funds close worldwide bets that were financed at near zero rates in Tokyo. Japanese investors began to repratriate their vast foreign holdings.

The surging yen has played havoc with the balance sheet of Japan's leading exporters. Every one yen appreciation against the dollar and euro shaves Toyota's profits by $450m. The company is now underwater, facing its first loss since 1938. The risk is that Japan could slide back into a deflationary crisis and renewed perma-slump. The country's `Lost Decade' never seems to end.

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Protectionist Dominoes Are Beginning To Tumble Across The World
The Riots Have Begun. Civil Protest Is Breaking Out In Cities Across Russia, China, And Beyond.

By Ambrose Evans-Pritchard | 22 December 2008

Greece has been in turmoil for 11 days. The mood seems to have turned "pre-insurrectionary" in parts of Athens— to borrow from the Marxist handbook. This is a foretaste of what the world may face as the "crisis of capitalism"— another Marxist phase making a comeback— starts to turn two hundred million lives upside down.

We are advancing to the political stage of this global train wreck. Regimes are being tested. Those relying on perma-boom to mask a lack of democratic or ancestral legitimacy may try to gain time by the usual methods: trade barriers, sabre-rattling, and barbed wire. Dominique Strauss-Kahn, the head of the International Monetary Fund, is worried enough to ditch a half-century of IMF orthodoxy, calling for a fiscal boost worth 2% of world GDP to "prevent global depression".

"If we are not able to do that, then social unrest may happen in many countries, including advanced economies. We are facing an unprecedented decline in output. All around the planet, the people have reacted with feelings going from surprise to anger, and from anger to fear," he said.

Russia has begun to shut down trade as it adjusts to the shock of Urals oil below $40 a barrel. It has imposed import tariffs of 30% on cars, 15% on farm kit, and 95% on poultry (above quota levels). "It is possible during the financial crisis to support domestic producers by raising customs duties," said Premier Vladimir Putin. Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licences" to choke off imports.

The Kremlin is alarmed by a 13% fall in industrial output over the last five months. There have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul. Police crushed "Dissent Marchers" holding copies of Russia's constitution above their heads in Moscow's Triumfalnaya Square. "Russia has not seen anything like these nationwide protests before," said Boris Kagarlitsky from Moscow's Globalization Institute.

The Duma is widening the treason law to catch most forms of political dissent, and unwelcome forms of journalism. Jury trials for state crimes are to be abolished. Yevgeny Kiseloyov at the Moscow Times said it feels eerily like 1 December 1934 when Stalin unveiled his "Enemies of the People" law, kicking off the Great Terror. The omens are not good in China either. Taxis are being bugged by state police. The great unknown is how Beijing will respond as its state-directed export strategy hits a brick wall, leaving exposed a vast eyesore of concrete and excess plant.

Exports fell 2.2% in November [alone]. Toy, textile, footwear, and furniture plants are being closed across Guangdong, now the riot hub of South China. Some 40m Chinese workers are expected to lose their jobs. Party officials have warned of "mass-scale social turmoil".

The Chinese Politburo is giving mixed signals. We don't yet know how much of the country's plan to boost domestic demand through a $586bn stimulus package is real, and how much is a wish-list sent to party bosses in the hinterland without funding. Shortly after President Hu Jintao said China is "losing competitive edge in the world market", we saw a move towards export subsidies for the steel industry and a dip in the yuan peg— even though China already has the world's biggest reserves ($2 trillion) and the biggest trade surplus ($40bn a month).

So is the Communist Party mulling a 1930s "beggar-thy-neighbour" strategy of devaluation to export its way out of trouble? Such raw mercantilism can only draw a sharp [response] from Washington and Brussels in this climate. "During a global slowdown, you can't have countries trying to take advantage of others by manipulating their currencies," said Frank Vargo from the US National Association of Manufacturers.

It is a view shared entirely by President-elect Barack Obama. "China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for American firms and workers, not good for the world," he said in October. The new intake of radical Democrats on Capitol Hill will hold him to it.

There has been much talk lately of America's Smoot-Hawley Tariff Act, which set off the protectionist dominoes in 1930. It is usually invoked by free traders to make the wrong point. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly.

Britain and the Dominions retreated into 'Imperial Preference'. Other countries joined. This became the "growth bloc" of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.

It was a successful strategy— given the awful alternatives— and was the key reason why Britain's economy contracted by just 5% during the Depression, against 15% for France, and 30% for the US. Could we see such a closed "growth bloc" emerging now, this time led by the US, entailing a massive rupture of world's trading system? Perhaps. This crisis has already brought us a monetary revolution as interest rates approach zero across the G10. It may overturn the "New World Order" as well, unless we move with great care in grim months ahead.

This is where events turn dangerous. The last great era of globalisation peaked just before 1914. You know the rest of that story.

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The Federal Reserve Is Damned Either Way As It Battles Debt And Deflation
We Know What Causes A Recession To Metastasize Into A Slump. Irving Fisher, The Paramount US Economist Of The Inter-War Years, Wrote The Text In 1933: "Debt-Deflation Theory Of Great Depressions".

By Ambrose Evans-Pritchard | 18 December 2008

"Such a disaster is somewhat like the capsizing of a ship which, under ordinary conditions is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but [has, rather,] a tendency to depart further from it," he said. Today we call this "Gladwell's tipping point". Once you pass it, you can't get back up. This is why the Federal Reserve has resorted [so quickly] to emergency measures that seem mad at first sight.

It has not only cut rates to near zero for the first time in US history, it is also conjuring $2 trillion of stimulus out of thin air. This is 'Quantitative Easing', or just plain 'QE' in our brave new world. The key is the toxic mix of high debt and deflation. An economy can handle one at a time, but not both.

The reason why it "departs further" from equilibrium is more or less understood. The burden of debt increases as prices fall, creating a self-feeding spiral [[a 'negative feedback' effect: normxxx]]. This is what Fisher called the "swelling dollar" effect. Real debt costs rose by 40% from 1929 to early 1933 by his count. Debtors suffocated to death.

Brian Reading from Lombard Street Research has revived this neglected thesis and come up with some disturbing figures. US household debt is now $13.9 trillion, down just 1% from its peak last year. Meanwhile household wealth has fallen 14% as property crashes, a loss of $6.67 trillion [[even more, if we add in the losses in the stock and bond markets: normxxx]]. The debt-to-wealth ratio is rocketing.

Clearly the US is already in the grip of debt-deflation. "The obvious conclusion is that the Fed should print money to purchase private sector assets so as to drive up their price," he said. Fed chief Ben Bernanke does not need prompting. He made his name as a Princeton professor studying the "credit channel" causes of depressions. Now fate has put him in charge of the channel.

Under his guidance, the Fed has this week pledged to "employ all available tools" to stave off deflation— and damn the torpedoes. It will purchase "large quantities of agency debt and mortgage-backed securities." It will evaluate "the potential benefits of purchasing longer-term Treasury securities," i.e, 'printing' money to pay the Pentagon.

Put bluntly, the Fed is deliberately stoking inflation. At some point it will succeed. Then the risk flips quickly to spiralling inflation as the elastic snaps back. That will be a second point of danger.

By late 2009, if not before, the bond vigilantes may start to fret about the 'liquidity lake'. They will worry that the Fed may have to start feeding its holdings of debt back onto the market. The Fed's balance sheet has already risen from $800bn in September to $2.2 trillion this month. It will be $3 trillion by early next year.

"The bond markets could go into free fall," said Marc Ostwald from Monument Securities. "The Fed went into this with all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said.

New Star's Simon Ward said all three measures of the US broad money supply are flashing recovery. M2 has risen at annual rate of 17% over three months. "It has all changed since the Fed began buying commercial paper in October. If the money supply is booming at 20% in six months, inflation will become a concern. Given that public debt ratios are already on an explosive path, we risk a debt trap," he said.

For now, the bond markets are quiet. Futures contracts are pricing in five years of deflation in the US. Yields on 10-year US Treasuries have halved since early November to 2.09%, the lowest since the Fed's data began. Three-month dollar LIBOR has plummeted to 1.53%. [[And the dollar has plummeted in value.: normxxx]]

It is the same pattern across the world. 10-year yields have fallen to 1.27% in Japan, 3% in Germany, 3.2% in Britain, and 3.49% in France. The bond markets seem to be betting that emergency action by central banks will take a very long time to work, if it works at all. By cutting to zero, the Fed has come close to shutting down the US 'repo' market that plays a crucial role in providing liquidity.

It has caused havoc to the $3.5 trillion money markets— as the Bank of Japan, burned by experienced, had warned. It has become even harder for banks to raise money. Some argue that 'extreme' monetary policy is already doing more harm than good. Mr Bernanke is known for his "helicopter speech" in November 2002, when he nonchalantly talked of the Fed's "printing press" and said it was the easiest thing in the world to "reverse deflation".

Less known is his joint-paper in 2004— "Monetary Policy Alternatives At The Zero-Bound". By then doubts were creeping in. He admitted to "considerable uncertainty" as to whether 'extreme' tools would actually work. Liquidity could fail to gain traction. Put another way, the Fed is flying by the seat of its pants. It should never have let debt grow to such grotesque levels in the first place.

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Fresh Credit Strains In Europe As Deutsche Bank Shocks Markets
Deutsche Bank Has Refused To Redeem A Bond Issue In An Unprecedented Move That Has Rattled Europe's Credit Markets And Cut Short The Relief Rally Following America's Dramatic Move To Zero Rates.

By Ambrose Evans-Pritchard | 17 December 2008

The news set off a fresh flight from European bank debt. Credit default swaps (CDS) on the iTraxx Financial index measuring stress in the sector saw the biggest jump since the Lehman Brothers crisis, rising 20 points to 226. Adding to the gloom, Standard & Poor's warned that a fifth of all lower-rated companies in Western Europe and the UK are likely to default over the next two years, greatly exceeding the scale of bankruptcies after the dotcom bust. The agency said up to 75 companies that issue debt in the capital markets would fail in 2009 as they struggle to roll over debt. Four have failed this year.

Deutsche Bank, Germany's top lender, said it had 'chosen not to exercise' a "call option" on a subordinated bond worth €1bn (£930bn), breaking an iron-fast 'code' in the credit markets. The bank's share price fell 7% in Frankfurt, and the default insurance on the it's debt surged. "This has never happened before," said Willem Sels, a credit strategist at Dresdner Kleinwort. "Banks have never wanted to do it because it upsets investors and could mean that future funding will be hit."

Deutsche Bank, run by Josef Ackerman, is within its legal rights. The contract lets the bank accept an automatic rise in interest costs after five years, or call the option and raise money on the open market. Ronald Weichert, the bank's spokesman, said it would have been "much more expensive" [[if not impossible: normxxx]] to secure fresh finance in the current climate. "The situation has changed, and we had to decide what to do in the appropriate interests of Deutsche Bank," he said.

The travails at Deutsche are the latest sign that credit stress is continuing to plague Europe's lenders, despite a blanket bail-out by EU governments in September. The European Central Bank warned in its Financial Stability Report this week that lenders are at risk from a deeper slowdown than expected. "Banks need to be especially vigilant in ensuring that they have adequate capital and liquidity buffers to cushion the risks that lie ahead," it said.

The European Central Bank (ECB) is coming under heavy pressure to follow the Federal Reserve and central banks of Canada, Britain, Switzerland and Sweden in slashing rates and exploring emergency options. Norway cut rates by 175 basis points to 3% on Wednesday. Eurozone prices fell 0.5% in November and may be flirting with deflation by the middle of next year.

The region is falling into deep recession. Berlin expects the economy to contract by 2% next year in the worst slump since World War Two, according to German press leaks. Italy is facing two years of contraction. Concerns are spilling over into the debt markets. Yields on Italy's 10-year bonds have risen to 132 basis points above German Bunds, partly on concerns that Italy may have trouble rolling over €200bn next year.

Jean-Claude Trichet, the ECB's president, this week hinted that the bank may hold rates at 2.5% in January. "Do we have a feeling there is a limit to the decrease in rates? At this stage certainly yes. We have to beware of being trapped at nominal rates that would be much too low."

ECB hawks have been warning that extreme rate cuts are 'unhealthy' and likely to lead to inflation down the road [[strongly reminiscent of Japan's (more or less successful) hawks in the early '90s: normxxx]], although there have been rumblings of discontent from the Dutch, Cypriot, Portuguese and Spanish members. There is now a stark divide in philosophy between the ECB and almost every other central bank. The result has been a sudden shift of funds into the euro over recent days, pushing it to $1.44 against the dollar and a record €1.0758 against sterling.

[ Normxxx Here:  Beware of a sudden surge in the dollar/euro exchange when the ECB finally caves.  ]

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Sterling [The Dollar] Fall Is A Life-Saver For UK [US] Economy

By Ambrose Evans-Pritchard | 19 December 2008

The sharp slide in the pound has been a godsend for the UK economy and may have helped Britain avert a much more serious crisis, according to the German bank Dresdner Kleinwort. [[And the recent 'crash' of the dollar may just have similar effects for the US: normxxx]].

"If the currency had not gone down so far, think how much worse it could have been. A weaker sterling is just what you need in the current situation," said David Owen, the bank's chief economist for developed markets. He said exporters are taking advantage of the 20% fall in sterling [[or the over 10% slide of the dollar: normxxx]] to boost profit margins, giving them a vital cushion to help survive the collapse in lending. This is the same pattern seen after the ejection of the pound from Europe's Exchange Rate Mechanism in 1992.

"Export margins are going through the roof, and this helps not just manufacturing but also service exports. Profits are holding up surprisingly well. With banks threatening to cut off credit lines, these companies need all the help they can get," he said.

"We have been in a train-wreck since August 2007 and it is going on and on. Credit insurance [[think AIG: normxxx]] is drying up. We are hearing anecdotal evidence that banks are telling custormers not to rely on them for finance next year. If credit lines are cut off, even good companies will go into receivership," he said.

The concern is that there may be two more shoes to drop in this crisis. The wave of corporate defaults has hardly begun, and inventories are still too high for this stage of the cycle. [[In the US, we still have another wave of foreclosures due to ARMs mortgage rate resets and job losses, and expect more bank and other corporate failures. The government may bailout Citygroup and Detroit, but who else?: normxxx]]

"The good thing is that the authorities have thrown an awful lot of ammo at this problem. We're effectively moving towards zero interest rates in all the major economies. But we know from Japan that the central banks can pump liquidity into the system but that doesn't guarantee recovery if the banks won't lend," he said.

The risk [[for the UK: normxxx]] is that foreign investors stop buying Gilts and other forms of British debt, setting off a pound exodus that could spin out of control— as happened to Iceland's krona. UK bond auctions have held up well so far.

Mr Owen said newspaper columnists fretting about a sterling 'crisis' should remember what happened in the early 1930s when Britain was the first major economy to leave the Gold Standard and reflate through devaluation (and rate cuts). While the episode was humiliating at the time, it was a key reason why the UK economy contracted by just 5% during the Great Depresssion compared to 15% for France and 30% for the US.

Stephen Jen, currency chief at Morgan Stanley, said sterling is a "high-beta" currency, meaning that it is highly-geared to the global economic cycle. It shoots up during good times and plunges during bad times. It should return to health if and when the world emerges from economic winter..

The Bank of England's view is that sterling has served its purpose well in this crisis, acting as a shock-absorber.

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Mr Bernanke Correctly Judged The Risk Of Deflation

By Ambrose Evans-Pritchard | 17 December 2008

US consumer prices are dropping at the fastest rate since January 1932 on a strict dollar for dollar basis. New house building fell by 18.9% in November to 625,000, the lowest since records began half a century ago. It is not yet clear whether America is sliding into a deflation trap but the risk is grave enough to justify radical measures as insurance against a potentially disastrous chain of events. The sort of deflation now spreading across North America, Japan, and parts of Europe is not of the [often relatively] benign variety of the late 19th century when prices slid gently for year after year. Debt levels are much higher today [[incredibly so; in the 19th century, hardly anyone carried any debt, except for arrears on payments due, or the priveleged few— the latter perhaps a few percent of the total population: normxxx]], so the deflation effect [[of increasing the real value of the debt with time: normxxx]] is that much more dangerous. The danger is that of a self-feeding downward spiral [[a 'negative feedback' effect: normxxx]] as the real burden of debt keeps rising into the slump, as Irving Fisher dissected in his great opus "The Debt-Deflation Theory of Great Depressions".

US inflation was minus 1.7% in November, and minus 1% in October. This entirely vindicates the brave decision by Ben Bernanke at the US Federal Reserve— and our our own Mervyn King at the Bank of England— to "look through" the oil spike earlier this year and keep his focus on the underlying forces at work in the global economy. While Mr Bernanke may have been caught flat-footed by the onset of the credit crisis in the summer of 2007, he has since moved with impressive speed. The string of emergency rate cuts this year have now brought America to the brink of zero.

They may prevent the current credit crash from metastasizing into a full-blown depression. We do not yet know for sure. It takes a year or so for the effects of monetary policy to feed through the economy even when the banking system is functioning. It will take even longer this time. But matters would undoubtedly be worse if the Fed’s backwoodsmen had succeeded in imposing a liquidation squeeze on the US economy, as they did from 1930 to 1932.

Mr Bernanke has not run out of ammunition yet. He has a nuclear arsenal, and has begun to use it. [[And means to use it!: normxxx]] The Fed is already buying mortgage debt. It has infinite means of injecting stimulus into the economy by `quantititive easing’, if needs be. It can ultimately print money and hang it on Christmas trees.

Mr Bernanke correctly judged the risk of deflation. His critics did not anticipate this current, sudden price collapse. The burden in now on them to explain why they are so sure that deflation can be safely left to run its malign course.

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[The Germany Bully] Gets A Free Ride With Its Beggar-Thy-Neighbour Policy
For The First Time In My Life, I Am Starting To Feel Twinges Of Anti-German Sentiment.

By Ambrose Evans-Pritchard | 15 December 2008

This does not come naturally. My father insisted on German au pair girls during my childhood as his gesture towards post-War comity. I later did a stint at Mainz University dabbling in Kant (great) and Hegel (a fraud).

But even Teutophiles who think that Germany has played an enlightened role for 60 years are losing patience with the antics of the finance ministry and Bundesbank, and with the dictatorial turn in Berlin's EU strategy. Put bluntly, Germany is pursuing a beggar-thy-neighbour policy. It is not fulfilling its responsibilities as the world's top exporter and pivotal power of Europe's monetary union. It is leaching off global demand, even as it patronizes Anglo-Saxons, Latins, and Slavs.

No doubt binge debtors in the Anglosphere are much to blame for this crisis. But Germany rode the boom too. It made those Porsches and BMWs driven by the new rich. Its banks are among the most leveraged in the world.

Nor should we not forget that the European Central Bank set interest rates at recklessly low levels early this decade to help Germany out of a slump. Can this be separated from the property bubbles in Club Med, Holland, Ireland, Scandinavia, and Eastern Europe now causing such grief? Within the EMU, Germany has gained a competitive edge against France, Italy, and Spain for year after year by screwing down wages. In pre-euro days the North-South rift did not matter. The D-Mark revalued. Balance was restored. In the monetary union, it is toxic.

Germany now has a current account surplus of 7% of GDP. It is hollowing the industrial core of Latin Europe. Yes, Club Med needs to pull its socks up, but the flip side of the coin is that Germany is in breach of EMU's implicit contract.

The rules of the game are that surplus countries should boost demand. The Gold Standard collapsed in the early 1930s because they— then the US and France— refused to do so. The burden of adjustment fell on deficit states, who had to tighten yet harder. The downward spiral dragged everybody into depression.

Germany and China are today's violators. Their trade surpluses over the last 12 months have been $283bn and $279bn, respectively. They are exporting excess capacity.

Peer Steinbrück, Germany's finance minister, seems in no mood to yield. He prefers to mock the "crass Keynesianism" of the British. Nobel Laureate Paul Krugman was so disgusted that he broke away from his Stockholm banquet to pen The Economic Consequences of Herr Steinbrück.

"The world economy is in a terrifying nosedive, visible everywhere. The high degree of European economic integration gives Germany a special strategic role right now, and Mr Steinbrück is doing a remarkable amount of damage. There's a huge multiplier effect at work; it is multiplying the impact of German boneheadedness," he said.

Meanwhile, the Bundesbank has been doing its bit for depression. Germany's two ECB members— caught in a 1970s time-warp— orchestrated the mad rate rise in July. They are now trying to head off cuts in January, saying the ECB cannot risk using up its ammo. Even Switzerland's uber-hawks have ditched that doctrine.

Worst of all is Germany's [wicked] role in dredging up the EU Constitution (Lisbon Treaty) after it had been rejected by French and Dutch voters. Having made one blunder, they are now making another by refusing to accept the Irish verdict as well. Why are they so maniacal about this? Because the treaty establishes German primacy in the EU's voting structure. This is raw national interest— camouflaged, of course.

So Brian Cowen— already the most reviled Taoiseach [[the equivalent of a prime minister: normxxx]] since the creation of the Irish state— is bludgeoned into a second vote. This is what now passes for EU statecraft. A tactical case can be made, that fear will induce Irish voters to change their minds as GDP contracts by 4% next year. Even if that proves correct, will it convince anybody that the European Project is advancing with democratic assent?

What if the Irish vote 'No' again? Will Germany carry out its threat to "suspend" them from the EU, and thereby risk a final revulsion against Europe and the unravelling of the post-War order? One notes that Germany has acquired the taste for bullying small nations [[wrong; Germany and Germans have always had 'the taste for bullying small nations' and 'underdogs'— one had been led to expect that they had outgrown it— one was obviously wrong: normxxx]]. Mr Steinbrück threatened to "take a whip" to Switzerland. The sooner Germans take a whip to Mr Steinbrück and all he stands for, the better. Otherwise the rest of us will have to start examining our options.

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Switzerland May Have To 'Print' Money To Stave Off Deflation
The Swiss National Bank Has Cut Interest Rates To 0.5% And Opened The Door For Emergency Stimulus, Becoming The First Country In Europe To Flirt With Zero Policy Rates.

By Ambrose Evans-Pritchard | 12 December 2008

South Korea cut to 3% and Taiwan cut to 2%, the lowest in 30 years. Both countries are facing a collapse in exports to China and traditional markets in the West. Thomas Jordan, a board member of the Swiss National Bank (SNB), said the bank was mulling 'extreme' measures to stabilise the financial system and cushion the economy as it falls into recession next year.

"We could engage in 'quantitative easing' and we could intervene in foreign exchange markets or we could buy up bonds and try to influence long-term interest rates. All these options are open and we're not limited in any way in choosing from among these instruments," he said. Quantitative easing is the tool pioneered by the Bank of Japan to stave off deflation. It is tantamount to just printing money.

David Bloom, currency chief at HSBC, said the shift in policy was breathtaking. "The SNB are the hard men of central banking; they are even harder than the European Central Bank. What they are saying is that inflation is no longer a problem, it's the solution. They want stimulus any way they can get it."

The banking sector makes up 20% of Swiss GDP, leaving the country extremely exposed to the credit crisis. The liabilities of Credit Suisse and UBS are equal to seven times national GDP. This has echoes of the situation in Iceland before the country collapsed, although Swiss banks have a much better mix of assets.

"The crucial difference is that the Swiss own half a trillion dollars of external assets. They have a current account surplus of 16% of GDP. This is their ace in the hole. If push ever comes to shove, the Swiss taxpayers have the money to pay," said Mr Bloom.

Switzerland, Sweden, Britain, and Canada are all now following the US Federal Reserve in taking revolutionary action to head off a slump next year, while the ECB has moved with much greater caution. It is unclear whether this reflects a rift in doctrinal policy, or whether the ECB is less able to respond to crises because of its treaty-bound institutional structure. The ECB's chief theorist, Lorenzo Bini-Smaghi, said it was hazardous for central banks 'to cut rates too low and risk using up ammunition'.

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Asian Trade In 'Free Fall' As Exports To West Dry Up
The Economic Downturn In Asia Has Taken A Sharp Turn For The Worse As Japan Slides Into Deep Recession And Exports Contract In China, Korea, And Taiwan.

By Ambrose Evans-Pritchard | 10 December 2008

Asian trade in 'Free-Fall'

A blizzard of grim data this week points to a full-blown trade slump across Asia, confirming fears that the region's strategy of export-led growth would backfire once the West buckled. Flemming Nielsen, from Danske Bank, said exports from Korea and Taiwan both shrank by over 20% last month. "The numbers are terrible. Intra-Asian trade is in free-fall. Taiwan's exports to mainland China in November were down a whopping 42%."

The Baltic Dry Index measuring freight rates for bulk goods began to collapse in June, dropping 96% over the five months in the most dramatic fall in shipping fees ever recorded. It was a leading indicator of what we are now seeing in Asian trade. Fan Gang, a top adviser in Beijing, said China's exports would also show a decline when data is released this week. "Things are not good: industrial growth will be around 5% and export growth will be negative," he said. Economic expansion of 5% would be a major shock and entail recession in the Chinese context.

Japan's economy shrank 0.5% in the third quarter and risks sliding back into deflation and perma-slump. Exports fell 7.7% in October on crumbling demand for cars and machinery. Over 1,000 Japanese companies went bust last month as the high yen squeezed margins. Sony is laying off 16,000 staff.

Japan's industrial output is expected to fall by a post-War record of 8.6% in the fourth quarter. Tokyo is already planning "purchase vouchers" to kick-start spending in the world's second largest economy. A fresh stimulus package worth 20,000bn yen (£146bn) is being prepared for early next year.

"We need policies to keep the economy from falling apart," said economics minister Kaoru Yosano. "Japan will endure hardship next year." Zahra Ward-Murphy, from Dresdner Kleinwort, said Japan has slimmed down its bloated debt structure since its Lost Decade, but is still only half-reformed and over-reliant on exports. "It has not rebalanced the economy towards internal growth: now exports are tanking," she said.

Tokyo is once again running low on policy options. The Bank of Japan is wary of cutting rates below the current level of 0.3% for fear of damaging the money markets, a key lubricant of the credit system. [[It cut interest rates to 0.01% last Friday, tantamount to zero. : normxxx]] It may soon need to revert to emergency forms of monetary stimulus known as 'quantitative easing'.

Earlier rescue plans have already pushed Japan's national debt to 170% of GDP, the world's highest. Private savings have collapsed from 14% of GDP in the early 1990s to 2% today. Japan goes into this downturn without a cushion.

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BIS Warns Of Collapse In Global Lending
The City Of London Has Suffered A Dramatic Collapse In Its Core Business As Global Lending Falls At The Steepest Rate Since Records Began, According To New Figures From The Bank For International Settlements (BIS).

By Ambrose Evans-Pritchard | 9 December 2008

Cross-border loans worldwide fell by $1.1 trillion (£740bn) in the first half of the year, reflecting the scramble by the financial industry to cut leverage by pulling credit lines and slashing risky exposure. Foreign lending by UK banks fell by a staggering $884bn, equal to 81% of the entire contraction in international lending. The City is facing a double blow since worldwide issuance of bonds and securities has also gone into freefall, plummeting 77% from over a trillion dollars to $247bn in the third quarter.

The City has been the epicentre of Europe's structured credit industry. The collapse in bond issuance reflects the near-total closure of the capital markets in the late summer as credit spreads surged. Bonds issued in euros dropped by 94% from $466bn to $28bn over the quarter.

The UK banking sector includes branches of US, European, Asian and Mid-East institutions. These banks tend to use London as a base for their global credit and investment operations. Though foreign, they make up a crucial part of the City nexus and are a mainstay for accounting firms, lawyers and the panoply of financial services that enrich the City.

In its quarterly report, the BIS warned the US Federal Reserve, the Bank of England and other central banks that near-zero interest rates and emergency monetary stimulus may come at a cost. By opening the cash spigot, the authorities risk displacing the money markets and may "discourage banks from lending to other banks". The money markets are a crucial lubricant for the financial system, but they cannot function if rates fall too low. The sector can wither away, as Japan discovered during its "Lost Decade".

The BIS also hinted that the European Central Bank and Sweden's Riksbank may have blundered by raising rates this year to contain the oil shock. It said short-term energy spikes have no lasting effect on inflation or wage deals. "Evidence suggests an absence of strong second-round effects on inflation. The temporary inflationary impulse will soon drop out," it said.

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Deflation Virus Is Moving The Policy Test Beyond The 1930s Extremes
Debt Deflation Is Tightening Its Grip Over The Entire Global System. Interest Rates Are Creeping Towards Zero In Japan, America, And Now Across Most Of Europe. China Will Not Lift Us Out— They Are The Most Vulnerable Of All

By Ambrose Evans-Pritchard, Telegraph, UK | 9 December 2008

We are beyond the extremes of the 1930s. The frontiers of monetary policy are being pushed to limits that may now test the viability of paper currencies and modern central banking. You cannot drop below zero. So what next if the credit markets refuse to thaw? Yes, Japan visited and survived this policy Hell during its lost decade, but that was a local affair in an otherwise booming global economy. It tells us nothing. This time we are all going down together. There is no deus ex machina to lift us out. Certainly not China, which is the most vulnerable of all.

As the risk grows, officials at the highest level of the British Government have begun to circulate a six-year-old speech by Ben Bernanke— at the time of its writing, a garrulous kid governor at the US Federal Reserve. Entitled Deflation: Making Sure It Doesn’t Happen Here, it is the manual of guerrilla tactics for defeating slumps by monetary means.

"The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost," he said.

Critics had great fun with this when Bernanke later became Fed chief. But the speech is best seen as a thought experiment by a Princeton professor thinking aloud during the deflation mini-scare of 2002. His point was that central banks never run out of ammunition. They have an inexhaustible arsenal. The world’s fate now hangs on whether he was right (which is probable), or wrong (which is possible).

As a scholar of the Great Depression, Bernanke does not think that sliding prices can safely be allowed to run their course. "Sustained deflation can be highly destructive to a modern economy," he said [[and Japan has most recently borne witness to: normxxx]]. Once the killer virus becomes lodged in the system, it leads to a self-reinforcing debt trap— the real burden of mortgages and other loans rises, inexorably, year after year; house prices fall, inexorably, year after year. The noose tightens until you choke. Subtly, it shifts wealth from workers to bondholders [[and like well heeled lenders: normxxx]]. It is reactionary poison. Ultimately, it leads to civic revolt. Democracies do not tolerate such social upheaval for long. They change the rules. [[And it was why Thos. Jefferson, for one, so sternly warned us against bankers in general and central banks in particular. And just perhaps why both Central banks in the US prior to the Fed were each ended by act of Congress in order to end a serious deflation, brought on by severe recession, panic, and hard money. Very hard, as the Fed of 1930 can attest to.: normxxx]]

Bernanke’s central claim is that the big guns of monetary policy were never properly deployed during the Depression, or during the early years of Japan’s bust, so no wonder the slumps dragged on. The Fed can create money out of thin air and mop up assets on the open market, like a sovereign sugar daddy. "Sufficient injections of money will ultimately always reverse a deflation." Bernanke said the Fed can "expand the menu of assets that it buys".

US Treasury bonds top the list, but it can equally purchase mortgage securities from US agencies such as Fannie, Freddie and Ginnie, or company bonds, or commercial paper. Any asset will do. The Fed can acquire houses, stocks, or a herd of Texas Longhorn cattle if it wants. It can even scatter $100 bills from helicopters. (Actually, Japan is about to do this with 'shopping' coupons!)

All the Fed needs is the 'emergency powers' under Article 13(3) of its code. This "unusual and exigent circumstances" clause was indeed invoked— very quietly— in March to 'save' the US investment bank Bear Stearns. There has been no looking back since. Last week the Fed began printing money to buy mortgage debt directly. The aim is to drive down the long-term interest rates used for most US home loans. The Bernanke speech is being put into practice, almost to the letter.

No doubt, such reflation a l’outrance can "work", but what is the exit strategy? The policy leaves behind a liquidity lake. The risk is that this will flood the system once the credit pipes are unblocked. The economy could flip abruptly from deflation to hyper-inflation.

Nobel Laureate Robert Mundell warned last week that America faces disaster unless the Bernanke policy is reversed immediately. This is a minority view, but one held by a disturbingly large number of theorists. History will judge.

Most central bankers suffer from a déformation professionnelle. Those shaped by the 1970s are haunted by ghosts of libertine excess. Those like Bernanke who were shaped by the 1930s live with their Depression poltergeists.

His original claim to fame was work on the "credit channel" causes of slumps. Bank failures can snowball out of control as the "financial accelerator" kicks in. The cardinal error of the 1930s was to let lending contract [[at least during the first half of 1930, in order to stave off the loss of gold, mostly to France: normxxx]].

This is why he went nuclear in January, ramming through the most dramatic rates cuts in Fed history. Events have so far borne him out. A case can be made that Bernanke’s pre-emptive blitz has greatly reduced the likelihood of catastrophe. It was no mean feat given that he had to face down a simmering revolt earlier this year from the Fed’s own regional banks.

The sooner the Bank of England tears up its rule books and prepares to follow the script in Bernanke’s manual, the more chance we too have of avoiding a [horrible end]. Monetary stimulus is a better option than the fiscal sprees that leave us saddled with public debt— the path that nearly wrecked Japan [[and who is not yet out of the woods: normxxx]].

Yes, I backed the Brown stimulus package— with a clothes-peg over my nose— but only as a 'one-off' emergency. Public spending should be a last resort, as Keynes always argued. Of course, Bernanke should not be let off the hook too lightly. Let us not forget that he was deeply complicit in creating the disaster we now face. He was a cheerleader of Alan Greenspan’s easy-money stupidities from 2003-2006. He egged on debt debauchery.

It was he who provided the theoretical underpinnings of the Greenspan doctrine that one could safely ignore housing and stock bubbles because the Fed could simply "clean up afterwards". Not so simply, it turns out.

As Bernanke said in that 2002 speech: "the best way to get out of trouble is not to get into it in the first place". Too late now.

ߧ

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Stock Investors Lose Faith, WSJ

Stock Investors Lose Faith, Pull Out Record Amounts
Click here for a $$link to complete article:

By E.S. Browning, WSJ | 21 December 2008

One of the hallmarks of the long market downturns in the 1930s and the 1970s has returned: Rank-and-file investors are losing faith in stocks. In the grinding bear markets of the past, huge stock losses left individual investors feeling burned. Failures of once-trusted firms and institutions further sapped their confidence. Many disenchanted investors stayed away from the stock market, holding back gains for a decade or more.

Today's investors, too, are surveying a stock-market collapse and a wave of Wall Street failures and scandals. Many have headed for the exits: Investors pulled a record $72 billion from stock funds overall in October alone, according to the Investment Company Institute, a mutual-fund trade group. While more recent figures aren't available, mutual-fund companies say withdrawals have remained heavy.

If history is any guide, they may not return quickly.

Individual investors arguably form the bedrock of the market. It's difficult to pinpoint how much stock they hold, because they own shares through mutual funds, retirement accounts and other vehicles. But once retirement accounts are factored in, individuals likely account for half or more of all U.S. stock holdings, according to data from Birinyi Associates in Westport, Conn. Investors' discomfort with stocks has been growing for years, since just after the 2000 selloff of dotcom shares.

"I don't have any confidence in buying any new stocks," says David Herrenbruck, a 52-year-old New York photographer at the peak of his ability to save and invest. Mr. Herrenbruck was a big believer in stocks in the late 1990s, but he was burned by the tech-stock meltdown. He has since moved much of his money to real estate, and he has recently invested in bonds and certificates of deposit. "If I have some cash lying around, it is going to be in CDs," he says.

From 2002 through 2005, investors put an average of $62 billion a year into U.S. stock mutual funds, less than half the annual level of the previous decade. Since 2006, investors have been pulling money out of U.S. stock funds at a [net] rate of about $40 billion a year. Such skittishness already promises to put a brake on the stock market's recovery, which could make it harder for companies to raise capital and could squeeze financial firms' profits. That, in turn, could delay the economy's emergence from the severe recession that began last year.

Individuals aren't the only ones who have become skeptical of stocks. Many of the buyers who pushed indexes to record levels this decade— including private-equity firms and hedge funds— also appear to be increasingly looking beyond stocks. College endowments and hedge funds, for example, have in recent years funneled more money into alternative investments such as real estate, commodities, art, and even farms and timberland.

Lessons Learned

There's no way to know how long individuals could stay away from shares. Their confidence could be restored more quickly than in the past, optimists say, pointing to policymakers' efforts to avoid repeats of the 1930s and 1970s. Federal officials have sought to stabilize financial markets by injecting hundreds of billions of dollars, slashing target interest rates for overnight loans to nearly zero, and announcing plans to buy up mortgage-backed securities. Also, today's individual investors are different than those of past eras. In the 1930s and 1970s, stock investing was the province of a minority of rich Americans. Now, thanks to 401(k) programs and other retirement plans, nearly half of U.S. families have stock holdings.

Some of the biggest nest eggs belong to baby boomers who are reaching retirement age. The market could receive a boost if many sidelined boomers, whose retirements could span decades, decide it is safe to shift sharply back to stocks. But if these investors believe their money will be safer stashed elsewhere for upcoming years, it could slow a market recovery.

Four-Decade Cycles

Peter Lush is among those steering mostly clear of company shares. The 61-year-old retiree in Georgia built up his retirement plan by investing in a fund that owned midsize stocks. Until recently, he says, he had much of his savings in a bond fund, and after corporate bonds took a hit, he moved the money into CDs. "Maybe now would be a good time to buy" stock, says Mr. Lush. "But I am scared, to tell you the truth."

Enthusiasm for shares has waxed and waned in long cycles, with previous flights from stocks occurring eight and four decades ago. In 1932, the Dow Jones Industrial Average— in those days a speculative index of relatively young companies— had fallen 89% from its 1929 high. The 1930s brought [rapid Cyclical] bull markets followed by bears, taking back gains and sapping investor confidence. [[Typical of the Secular Bear we were in then and now, since 2000.: normxxx]] The sustained troubles of the 1930s exposed scandals in speculative instruments.

So-called investment trusts used investor money and borrowed funds to buy high-flying securities, sometimes buying stock in one another. Of the 1,183 investment trusts and other funds that existed from 1927 through 1936, more than half had failed by 1937, a government study showed. Goldman Sachs, which sponsored three prominent funds that lost most of their value, saw its reputation damaged for years.

The Dow didn't return to its 1929 high until 1954. New York University financial historian Richard Sylla recalls that even in the 1950s, some people were so spooked by the Depression that they were storing money in jars in the basement. The stock recovery of the 1940s and 1950s became a speculative boom in the 1960s, marked by the so-called Nifty Fifty stocks that brokers said would rise for years. They didn't.

In 1966, the Dow flirted with the 1000 level, then shed 25%. That bull-and-bear pattern would repeat for 16 years amid [fairly severe] inflation and soaring oil prices. Investor confidence was hammered again.

There was scandal, too, including the early 1970s collapse of Bernie Cornfeld's mutual-fund empire, Investors Overseas Services, which at one point had assets of more than $2 billion. Mutual-fund data from that period show investors reacted much as they have in recent years. After a market peak in 1968, people began putting less money than before into mutual funds, Investment Company Institute data show.

By 1971, they were pulling more money out than they were putting in. From May 1972 through March 1980, total dollars in stock funds fell 42%. Mutual-fund executives worried that the industry might not survive. [[Business Week famously declared The Death Of Equities in its August 13th, 1979 issue.: normxxx]] Money started flowing in again in the 1980s, after the government encouraged broad market participation through 401(k) plans and other retirement programs. Individuals gradually embraced the idea of 'buy-and-hold' investing, helping to usher in the stock boom of the 1990s.

Pax Americana

With the Cold War 'over' and investments flowing across the globe, people [everywhere] believed they were in a long-running Pax Americana of world-wide prosperity and rising productivity. During the 1990s, investors added $1 trillion to mutual funds. The Dow Jones Industrial Average surged above 11000 in 1999, up tenfold from 1982. Owning anything but stocks looked foolish.

That confidence has been shaken by two bad bear markets in less than a decade. Between 2000 and 2002, the Dow fell 38% and the Nasdaq Composite Index shed 78%. This year's market collapse knocked 47% off the Dow in just over 12 months, returning stocks to 1997 levels. As of Friday, the Dow still was 39% off its 2007 record.

"The question is whether this series of very strong bear markets will cause investors to retrench as they did in the '70s," says Brian Reid, chief economist at ICI. "I think there will be some of that," he says, although perhaps not as bad as it was then. People in the investment business hoped ordinary investors would return in large numbers when the market began recovering late in 2002. But this didn't happen.

In 2001, 53% of U.S. households held stock or stock funds, which turned out to be a peak. Now, about 46% of families own stocks, according to a report published last week by the ICI and the Securities Industry and Financial Markets Association. [But t]he disaffection appears to be deepening. By the end of October, amid the most recent market collapse, retirement savers tracked by consulting group Hewitt Associates were sending 58% of their contributions to stock funds. That was down from 75% at the beginning of this year.

The decade's second bear market also brought big failures and scandals— the end of venerable investment banks [indeed, of all of those banks, amid some very suspect accounting practices and activities reminiscent of Enron], an alleged $50 billion swindle by Wall Street stalwart Bernard Madoff— to add to the collapses of Enron, WorldCom, and others from earlier in the decade.

"For many investors, this has been a glimpse into the abyss," says Terrance Odean, a finance professor at the University of California, Berkeley, who has studied the behavior of individual investors. "They have been told that if you save regularly for retirement and buy and hold, you will be fine. Now, people see a possibility that this will not be the case."

Weak Hands

The market has given Karin Kuder a good ride over the past two decades, but now she's through. Starting in 1989, Ms. Kuder contributed as much as she could to her retirement fund, up to 15% of each paycheck. In the 1990s, she chose aggressive stock funds, moving to a more conservative mix after the 2001 terrorist attacks. Early this year, even after she retired as a nurse at a naval air station in Jacksonville, Fla., Ms. Kuder still held 60% stocks and 40% bonds. In March, she trimmed her stock holdings to 50% of her portfolio. In October, with her account down $40,000, she ran out of confidence. "It was the only money I had," Ms. Kuder says. "I wasn't sleeping." She phoned her financial adviser and said she wanted to put all her money in a safe place. The adviser persuaded her to leave 20% in stocks and bonds, but the rest went to a five-year fixed annuity, similar to a certificate of deposit, guaranteeing 5.1% a year. "You put in all those years, and it is just falling right away from you," Ms. Kuder says. "I was so fearful that I was going to lose everything."

When market analysts talk about who's buying and who's selling in times like these, they sometimes speak of "weak hands" and "strong hands". Weak hands bail out when the market declines, seeking what they see as safer havens. 'Strong hands' are committed to the market for the long term, buying shares at what may turn out to be big discounts. Right now, the market is being driven by the exit of these 'weak hands'. Lasting recovery will come when some of these weak hands— or the next wave of younger investors— step back in.

There are signs that even younger investors are growing more fearful of stocks lately. Risk aversion has been on the rise this decade among all age groups, according to last week's report from the ICI and SIFMA. Although it will be long before young people need to tap their retirement savings, the losses they've seen in the current bear market could temper their enthusiasm for stocks for years to come.

Bright Future

Harris Cohen, a 25-year-old project manager with Amtrak in Washington, D.C., opened an individual retirement account in 2001, when he was 18, and filled it with stocks he thought had a bright future, including Apple Inc. and Garmin Ltd. He bought mutual funds that invest in alternative energy companies and utilities. He didn't bother with bonds. "I had a real good track record over five or six years, with increases from 10% to 20% a year," Mr. Cohen says. His portfolio has fallen about 40% over the past 18 months, he says. In September, he began pulling back from stocks. Now, he has shifted his retirement savings to corporate bonds, a money-market fund and a few utility funds. He says he doubts he ever will view stocks the same way. "Even if the market were to rebound and the economy were to improve, I would be very loath to invest entirely in stocks," Mr. Cohen says.

While investor confidence is low, there are signs that it may have further to fall.

In 2001, people's hopes for stocks were extremely high. Only 5% of those surveyed expected average annual stock returns in the coming decade to be 5% or less, according to University of Oregon Prof. Paul Slovic, whose company, Decision Research, conducts the surveys. Today, nearly one-third of those surveyed expect such stock weakness, reflecting the decline in investor optimism.

But there is a surprising amount of optimism left. More than half of the small investors surveyed still expect annual gains of 10% or more over the next decade— at, or above, historical averages. At some point, these optimists may be right. [But i]nvestors who jumped into the market at the height of the last love affair with stocks are still hurting.

A $10,000 investment in 2000, into a fund tracking the S&P 500 with dividends reinvested, would [today] be worth about $7,000, according to Morningstar Inc. Those who put $10,000 into the same index in 1982, at the end of the last decade of disaffection, would have more than $150,000. But see also this article within the quote within the quote by Peter Bernstein
Two Little-Noted Features Of The Markets And The Economy; and this article Stock Dividend Yields vs. Interest Rates: An 80 Year History at the blog Seeking Alpha.


Click Here, or on the image, to see a larger, undistorted image.

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

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Helicopter Ben Goes ZIRP!

Doctor Doom: Helicopter Ben Goes ZIRP!

By Nouriel Roubini | 20 December 2008

The Fed's Zero-Interest-Rate Policy. The Fed decision to cut the Fed Funds range to 0% - 0.25% has formalized the fact that, over the last month, the Fed had already moved to a zero-interest-rate policy, or ZIRP, and started a policy of 'quantitative easing' (QE) as its balance sheet has surged over the last few months from $800 billion to over $2 trillion. The Fed is now undertaking even more unorthodox policy actions. These actions are occurring while the U.S. and the global economy are at risk of a protracted bout of "stagdeflation" (stagnation and deflation).

While it is now fashionable to talk about such deflationary risks (and the latest U.S. Consumer Price Index figures confirm that we are entering into deflation) some of us were worrying about the coming deflation well before the mainstream— concerned with short-run and unsustainable increases in commodity prices— discovered the deflationary risks in the global economy. It was clear to those who saw, early on, the risks of a severe U.S. and global recession, that deflationary rather than inflationary pressures would emerge alongside a slack in goods, labor and commodity markets. Welcome to the world of stagdeflation or, as Paul Krugman would put it, the world of "depression economics."

So what is the outlook for 2009? And what is the likely policy response to the risks of a global stagdeflation?

The outlook for the U.S. and the global economy is now very bleak and getting worse as the global economy experiences its worst recession in decades. In the U.S., recession started last December and will last at least 24 months— until next December— the longest and deepest U.S. recession since World War II. The cumulative fall in gross domestic product may well exceed 5%.

In comparison, the last two recessions in 1990-91 and 2001 lasted only eight months each and the cumulative fall in GDP was only 1.3% and 0.4%, respectively. There is also a risk that this deep and protracted U-shaped recession may morph into a more severe Japanese style L-shaped recession unless aggressive fiscal policy and recapitalization of the financial system is enacted. (The former mainstream consensus view of a 'V-shaped, short and shallow' recession is now far out the window.)

The recession in other advanced economies (the euro zone, the U.K., other European economies, Canada, Japan, Australia and New Zealand) started in the second quarter of this year, before the financial turmoil in September and October further aggravated the global credit crunch. This contraction has become even more severe since then. I don’t expect growth in any of the advanced economies to recover before the end of 2009.

There is now also the beginning of a hard landing (growth well below potential) in emerging markets as the recession in advanced economies, falling commodity prices, and capital flight all take their toll on growth. Indeed, the world should expect a recession (growth in the -1% to -2% range) in Russia and a near recession (growth close to zero) in Brazil next year, owing to low commodity prices. There will also be a very sharp slowdown in China and India that will be the equivalent of a hard landing for these countries.

In China the latest figures for electricity use, exports and imports suggest that the economy is already close to the hard landing scenario of a growth rate of 5%. The deceleration of growth in China is much more rapid than expected. Other emerging markets in Asia, Africa, Latin America and Europe will not fare better and some may experience full-fledged financial crises.

More than a dozen emerging-market economies now face severe financial pressures: Belarus, Bulgaria, Estonia, Hungary, Latvia, Lithuania, Romania, Turkey and Ukraine in Europe; Indonesia, South Korea and Pakistan in Asia; and Argentina, Venezuela and Ecuador (a country that has just defaulted on its sovereign debt) in Latin America. What is the policy response in the U.S. and other countries to this risk of a global stagdeflation? The Fed decision to cut the target for the Fed Funds rate to the 0% to 0.25% range is just underwriting what was already obvious and happening in reality [[ie, the de facto rate has been replaced by the de jure: normxxx]]: While the 'target' Fed Funds rate was until Tuesday still nominally 1%, in the last few weeks— following the massive increase in liquidity by the Fed— the actual Fed Funds rate was already trading at a level close to 0%.

So the Fed just formalized what had already been happening for weeks now— that the Fed Funds rate was already zero and that the Fed had already moved to 'quantitative and qualitative easing' (QE) in the form of a massive increase in the monetary base and aggressive use of monetary policy to reduce short-term and long-term market rates that remain stubbornly high in a sign that the credit crunch is severe and worsening. I predicted early in 2008 that the Fed Funds rate "would be closer to 0% than to 1%" in the midst of a severe recession. Now, 12 months into this 'severe recession'— a recession that will last at least another 12 months (if not, as is very possible, much longer)— the Fed Funds rate is already down to 0% (the beginning of the zero-interest-rate-policy, or ZIRP, for the U.S.). The Fed has moved into uncharted, unorthodox monetary policy to offset the severe stagdeflation now taking place.

And, as predicted by me over a month ago, the Fed is now committed to keep the Fed Funds rate close to zero for a 'long time' [[— "as long as it takes": normxxx]] (as one way to push longer term Treasury yields lower). They have committed to purchasing agency debt and agency MBS in massive amounts, and 'are even considering' purchasing long-term Treasuries, directly, as a final way to push long-term government bond yields lower— that are already falling sharply. More aggressive policy actions may be undertaken by the Fed as the severe credit crunch shows no signs of relenting. In a 2002 speech on deflation, Ben Bernanke spoke of "helicopter drops of money," monetizing fiscal deficits, and even buying equities.

The latter actions have already been partially undertaken. The Fed is already monetizing U.S. fiscal deficits as the purchase of market assets is financed with the Fed printing presses rather than the TARP program. And now, with the Fed considering the purchase of long-term Treasuries, such monetization of deficits will simply be made more formal. [[Moreover, the "new fiscal stimulus", to be more than three times as much as the old, takes care of the "helicopter drops.": normxxx]]

Also, since the TARP has been turned into a program to 'recapitalize' financial institutions (and thus boost their capital and market value), the U.S. has already effectively intervened indirectly in the equity market (by partially nationalizing a good part of the financial system). Once the Fed starts to buy the long-term Treasuries financing the TARP program, this indirect Fed purchase of U.S. equities will be even clearer. While Fed actions to reduce mortgage rates— via purchases of agency debt and agency MBS— have been partially successful, inasmuch as long-term mortgage rates are falling— most of the Fed purchases of private assets have been so far limited to very high-grade securities.

Thus, the gap between the yield on high-grade commercial paper purchased by the Fed and the one that the Fed is not purchasing is rising sharply; ditto for the gap between agency MBS and private label MBS. Also, while long-term Treasury yields are falling sharply, the spread of corporate bonds— both high-yield and high-grade— relative to Treasuries remains huge as a sign of the severe continuing credit crunch. Thus, as a next step, the Fed may be soon forced to walk down the credit curve and start buying private short-term and long-term securities with lower credit ratings.

That would mean the Fed will take on even more credit risk than it is already taking on today while purchasing illiquid private assets. But desperate times lead to desperate actions by desperate policy makers.

[ Normxxx Here:  So Nouriel Roubini, the guru of gurus, who very early on provided the scenerio for this outcome, seems to be concurring with BB's moves; at least since the summer.  ]

Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Forced To Revise My Forecast!

Forced To Revise My Forecast!
Click here for a link to complete article:

By Sy Harding | 20 December 2008

I need to revise my recession forecast. As recently as last week I was predicting that while the recession would not turn into the next Great Depression, it would be as severe as that of 1973-74. I now don’t think it will be that severe after all.

I’ve been very accurate in my ‘big picture’ forecasts over the years. Nine years ago, in 1999, I wrote a book Riding the Bear— How to Prosper in the Coming Bear Market. In it I said the market was in a bubble similar to that of 1929, and the worst bear market since that of 1929-32 was just around the corner.

I was told that was ‘dinosaur-thinking’. The popular book of the time was Dow 36,000! But a few months later the severe 2000-2002 bear market began, in which the S&P 500 lost 50% of its value and the Nasdaq 78% of its value.

In 2005, I made the equally unpopular prediction that the real estate sector was in an unsustainable bubble, the bursting of which would cause at least as much trouble as the bursting of the stock market bubble. I was told I was wrong. The economy was strong, and lenders were making it possible for all Americans to own their own home. Therefore it would be many years before overbuilding would be a problem.

In April, 2007 I called the debt/credit situation a bubble that would be the next to burst. It seems to have done so this year.

In June of this year, with oil above $140 a barrel the consensus forecast was that it would hit $200 within a few months. I said not a chance, that oil was in a very overbought and unsustainable bubble. E-mailers told me I was wrong. There was no bubble, just soaring demand, and even if the U.S. economy slowed, China, India, and emerging countries would keep demand high for decades to come. My mistake was in predicting oil was due to plunge to $98 a barrel. It did that, and just kept on going down, now at $35 a barrel.

In a May, 2006 column I predicted "Banks are going to have severe problems again, this time evolving from high risk loans, investing for their own accounts in high risk derivatives, and their contribution to the creation of the real estate bubble… …Banks say they are not at risk because these days they don’t keep the mortgages on their books, instead packaging and selling them to hedge funds and investors." But we all know what happened a year later.

In early 2007 I said the Fed was behind the curve, and predicted the U.S. would be in a recession by year end 2007. Again I was told I was wrong, that the economy was strong and even weathering the bursting of the real estate bubble with no problem. And didn’t I realize that "even the Fed says the economy is resilient and employment remains strong, that the potential for rising inflation was the main concern". Well, we’re now in a recession, and they now say it began in December, 2007.

However, I need to revise my recession forecast. As recently as last week I was predicting that while the recession would not turn into the next Great Depression, it would be as severe as that of 1973-74.

I now don’t think it will be that severe after all.

My reasoning?

The problems facing the economy a year ago were so severe that I have said numerous times since, "It isn’t rocket science to expect that the worst housing meltdown in 30 years, the worst financial system crisis since the Great Depression, the worst consumer debt bubble ever, and a few other ‘worst ever’ conditions, would result in a worse than usual economic recession." However, I didn’t expect the government response to also be so massive and record-breaking. I’ve lost count of how many $trillions have been thrown at the problem in specific takeovers, bailout grants, loan provisions, and programs, to say nothing of the way the Fed has flooded the financial system with extra liquidity.

Some of it, perhaps most of it, has been hastily designed and poorly implemented. But it also doesn’t take a rocket scientist to know that if you hurl enough cannon loads of ammunition, as in massive overkill, even in the general direction of a target, a good deal of it will have an impact. Already financial firms are improving their balance sheets.

Sure, to some degree they’re doing so by putting some of the bailout money in their vaults rather than lending it out, and by using it to add to assets by taking over competitors. But they’re also closing branches, raising fees, and cutting back on employees and expenses. Once they’re sure they have restructured enough to survive, they will lend again. They must in order to move on to the next step of making profits again.

Now the bailout efforts are shifting to Main Street and employment. The most obvious was the White House decision to let the auto-makers borrow some of the TARP money that was originally intended only for financial firms. The decision was not made due to a desire to bail out the auto-makers, but to try to rescue the million or so related jobs.

Meanwhile, home-builders have drastically cut back on new home starts, the number of new homes on the market beginning to decline. And overall home prices have been dropping sharply, bringing them closer to fair-value based on wages. Affordability is also finally being helped by plunging mortgage rates.

The Treasury Department said a few weeks ago it is considering stepping in to force mortgage rates down to 4.5%. But rates are now improving on their own. The rate on 30-year mortgages has plunged from 6.5% in October to 5.1% this week, a 37-year low. And oil prices have fallen from $145 a barrel to less than $40, gasoline from $4 a gallon to $1.65, which also helps significantly.

The major remaining problem is employment. And more help is coming for that problem. President-elect Obama’s economic advisors have a $trillion stimulus package they hope Congress will have ready to sign within days of the new Administration taking over. This plan, ten times the amount of the last stimulus plan from Washington, will fund job-producing road, bridge, and other infrastructure construction, aimed at helping revitalize major industries in steel, cement, construction equipment, trucking, etc., and providing jobs for laid-off builders and construction workers.

I’ve been six to nine months early with my previous predictions of the last ten years. And I don’t mean this time that the economy will be booming next quarter. But I do see improvement coming down the road soon enough to prevent the recession from becoming as severe as that of 1973-74, as I had previously expected.

I hope I’m right, because if all this massive ammunition is being wasted and does not drive the enemy back, the battle will indeed have a bad ending.

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Second Mortgage Disaster

A Second Mortgage Disaster On The Horizon?
60 Minutes: New Wave Of Mortgage Rate Adjustments Could Force More Homeowners To Default

By Scott Pelley | 19 December 2008

The Mortgage Meltdown

(CBS) When it comes to bailouts of American business, Barney Frank and the Congress may be just getting started. Nearly two trillion tax dollars have been shoveled into the hole that Wall Street dug and people wonder where the bottom is. As correspondent Scott Pelley reports, it turns out the abyss is deeper than most people think because there is a second mortgage shock heading for the economy. In the executive suites of Wall Street and Washington, you're beginning to hear alarm about a new wave of mortgages with strange names that are about to become all too familiar. If you thought sub-primes were insanely reckless wait until you hear what's coming. One of the best guides to the danger ahead is Whitney Tilson. He's an investment fund manager who has made such a name for himself recently that investors, who manage about $10 billion, gathered to hear him last week. Tilson saw, a year ago, that sub-prime mortgages were just the start.

"We had the greatest asset bubble in history and now that bubble is bursting. The single biggest piece of the bubble is the U.S. mortgage market and we're probably about halfway through the unwinding and bursting of the bubble," Tilson explains. "It may seem like all the carnage out there, we must be almost finished. But there's still a lot of pain to come in terms of write-downs and losses that have yet to be recognized."

In 2007, Tilson teamed up with Amherst Securities, an investment firm that specializes in mortgages. Amherst had done some financial detective work, analyzing the millions of mortgages that were bundled into those mortgage-backed securities that Wall Street was peddling. It found that the sub-primes, loans to the least credit-worthy borrowers, were defaulting. But Amherst also ran the numbers on what were supposed to be higher quality mortgages.

"It was data we'd never seen before and that's what made us realize, 'Holy cow, things are gonna be much worse than anyone anticipates,'" Tilson says.

The trouble now is that the insanity didn't end with sub-primes. There were two other kinds of exotic mortgages that became popular, called "Alt-A" and "option ARMs." The option ARMs, in particular, lured borrowers in with low initial interest rates— so-called teaser rates— sometimes as low as one percent. But after two, three or five years those rates "reset." They went up. And so did the monthly payment. A mortgage of $800 a month could easily jump to $1,500. Now the Alt-A and option ARM loans made back in the heyday are starting to reset, causing the mortgage payments to go up and homeowners to default.

"The defaults right now are incredibly high. At unprecedented levels. And there’s no evidence that the default rate is tapering off. Those defaults almost inevitably are leading to foreclosures, and homes being auctioned, and home prices continuing to fall," Tilson explains. "What you seem to be saying is that there is a very predictable time bomb effect here?" Pelley asks.

"Exactly. I mean, you can look back at what was written in '05 and '07. You can look at the reset dates. You can look at the current default rates, and it's really very clear and predictable what's gonna happen here," Tilson says.

Just look at a projection from the investment bank of Credit Suisse: there are the billions of dollars in sub-prime mortgages that reset last year and this year. But what hasn't hit yet are Alt-A and option ARM resets, when homeowners will pay higher interest rates in the next three years. We're just at the beginning of a second wave.

"How big is the potential damage from the Alt As compared to what we just saw in the sub-primes?" Pelley asks. "Well, the sub-prime is, was approaching $1 trillion, the Alt-A is about $1 trillion. And then you have option ARMs on top of that. That's probably another $500 billion to $600 billion on top of that," Tilson says.

Asked how many of these option ARMs he imagines are going to fail, Tilson says, "Well north of 50 percent. My gut would be 70 percent of these option ARMs will default." "How do you know that?" Pelley asks.

"Well we know it based on current default rates. And this is before the reset. So people are defaulting even on the little three percent teaser interest-only rates they're being asked to pay today," Tilson says.

That second wave is coming ashore at a place you might call the "Repo Riviera"— Miami Dade County. Oscar Munoz used to sell real estate; now his company clears out the contents of foreclosed homes.

"Business is just going through the roof for us. Fortunately for us, unfortunately for the poor families who are going through this," Munoz explains. "I wonder do you ever come to houses where the people are still here?" Pelley asks.

"Absolutely," Munoz says. "That's really a sad situation. I'd rather not meet the people."

Asked why not, Munoz says, "It’s not easy to come in and move a family out. It's just our job to do it for the bank. It's just the nature of what's going in the market right now."

Munoz says his company alone gets about 20 to 30 assignments per day. "And we're one of the few companies right now who are hiring. We have to hire people because the demand is so high," he tells Pelley.

People who've been evicted tend to leave stuff behind. The evictee's next house is usually much smaller. Banks hire Munoz to move the possessions out where, by law, they remain for 24 hours. Often the neighbors pick through the remains. Once the homes are empty the hard part starts— trying to find buyers in a free-fall market.

Miami real estate broker Peter Zalewski talks like a man with a lot of real estate to move. "We have 110,000 properties for sale in South Florida today, 55,000 foreclosures, 19,000 bank owned properties. Sixty-eight percent of the available inventory is in some form of distress. They need someone to clean it up."

Asked what the name of his company is, Zalewski says, "It's called Condo Vultures Realty." What does that mean? "That in times of distress, and in times of downturn, there's opportunity. And you know, vultures clean up the mess. A lot of people seem to think they kill, but they don't actually kill, they clean up," he says.

The killing, in Miami, was done by the developers back when it seemed that the party would never end. They sold hyper-inflated condos at what amounted to real estate orgies-sales parties for invited guests who were armed with option ARM and Alt-A loans. "There were red ropes outside. They had hired cameramen, and they had hired photographers to almost set the scene of a paparazzi," Zalewski remembers.

"They were hiring fake paparazzi? To make the customers feel like they were special?" Pelley asks. "They were selling a lifestyle," Zalewski says.

Asked what roles these exotic mortgages played, Zalewski says, "They were essential. They were necessary. Without the Alt A or option ARM mortgage, this boom never would've occurred."

It never would have occurred because without the Alt As and the option ARMs, many buyers never would have qualified for a loan. The banks and brokers were getting their money up front in fees, so the more they wrote, the more they made.

"They stopped checking whether the income was even real. They turned to low and no-doc loans, so-called 'liar's loans' and jokingly referred to as 'ninja loans.' No income, no job, no assets. And they were still willing to lend," Tilson says.

"But help me out here. How does that make sense for the lender? It would seem to be reckless, in the extreme," Pelley remarks.

"It was," Tilson agrees. "But the key assumption underlying the willingness to do this was that home prices would keep going up forever. And in fact, home prices nationwide had never declined since the Great Depression." [[Besides, most of the mortgages were repackaged as "asset backed securities" of one form or another, eg, CMOs, and resold to gullible lenders around the world as 'pseudo-bonds'.: normxxx]]

On the way up, everyone wanted in. No one expected to feel any pain. People like acupuncturist Rula Giosmas became real estate speculators. Giosmas says she bought about six properties in this last five-year period as investments. She says she put 20 percent down on each. Now they're all financed with option ARM loans.

Asked what she understood about the loans, Giosmas says, "Well, unfortunately, I didn't ask too many questions. I mean in the old days, I would shop around. But because of the frenzy, and I was so busy looking to buy other properties, I didn't really focus on shopping around for mortgage brokers."

"But if you're investing in real estate, you're buying multiple properties, you should be asking a lot of questions," Pelley remarks. "Why didn't you ask?" "I was busy. I was really busy looking at property all the time, all day long," she replies. She also acknowledges that she didn't read the paperwork. Now she’s losing money on every property.

"You know that there are people watching this interview who are saying, 'You know, she was just foolish. She was greedy and foolish. She was buying small apartment buildings and wasn't paying enough attention to how they were financed,'" Pelley points out. "My full-time job is I'm an acupuncturist. So, this was just a side thing," she says.

Giosmas says she was misled and she hopes to renegotiate her loans. But many other buyers have simply walked away from their properties. One Miami luxury building was a sellout, but when 60 Minutes visited, a quarter of the condos were in foreclosure. Zalewski says one of those condos was originally purchased in October 2006 for $2.4 million. Now he says the asking price from the lender is $939,000. And there are more tough years to come because, just like the sub-primes, the Alt-A and option ARM mortgages were bundled into Wall Street securities and resold to investors. Sean Egan, who runs a credit rating firm that analyzes corporate debt, says he expects 2009 to be miserable and 2010 also miserable and even worse. Fortune Magazine cited Egan as one of six Wall Street pros who predicted the fall of the financial giants.

"This next wave of defaults, which everyone agrees is inevitably going to happen, how central is that to what happens to the rest of the economy?" Pelley asks. "It's core. It's core, because housing is such an important part. We're not going to get the housing industry back on track until we clear out this garbage that's in there," Egan explains.

"That hasn't cleared out yet. We haven't seen the bottom," Pelley remarks. "It's getting worse," Egan says. "There are some statistics from the National Association of Realtors, and they track the supply of housing units on the market. And that's grown from 2.2 million units about three years ago, up to 4.5 million units earlier this year. So you have the massive supply out there of units that need to be sold."

"What with the housing supply increasing that much, what does it mean?" Pelley asks. "It means that these problems, these economic difficulties, are not going to be resolved in a short period of time. It's not gonna take six months, it's not gonna 12 months, we're looking at probably about three, four, five years, before this overhang, this supply overhang is worked through," Egan says.

In the next four years, eight million American families are expected to lose their homes. But even after the residential meltdown, Whitney Tilson says blows to the financial system will keep coming.

"The same craziness that occurred in the mortgage market also occurred in the commercial real estate markets. And that's taking a little longer to show. But there are gonna be big losses there. Credit cars, auto loans. You name it. So, we're still, you know, we're maybe halfway through the mortgage bubble. But we may only be in the third inning of the overall bursting of this asset bubble," Tilson says.

"Does that mean that the stock market is gonna continue plunging as we've seen the last several months?" Pelley asks. "Actually we're the most bullish we've been in 10 years of managing money. And the reason is because the stock market, for the first time I can say this, in years, has finally figured out how bad things are going to be. And the stock market is forward looking. And with U.S. stocks down nearly 50 percent from their highs, we're actually finding bargains galore. We think corporate America's on sale," Tilson says.

The stock market will still have a lot of figuring to do with more troubling news on the horizon. The mortgage bankers association says one out of 10 Americans is now behind on their mortgage. That's the most since they started keeping records in 1979.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Backwardation Caught Us By Surprise.

Our Updated Take On Gold Prices: Backwardation Caught Us By Surprise.

By Vahid Fathi, D.Sc. | 19 December 2008

I never thought I'd see the day that gold markets went into backwardation (spot prices higher than futures prices). However, the seemingly unthinkable has indeed happened. Of course, I'm not suggesting that backwardation will be a permanent feature of the market, as the misalignment of interest rates that theoretically caused gold backwardation is most likely not a permanent feature, either. Nonetheless, the question remains: Where do we go from here?

This writer speculates that gold could very well turn out to be in a win-win situation, whether there is deflation or inflation. How is this possible? Adam Smith told us that gold is a barbaric relic, although it is more commonly known as the metal of kings. I remind you all that the world is still full of barbarians.

The above-ground stocks of gold, presumably available for disinvestment at any time, are some 60-fold of annual production of about 2,500 metric tons. This is why gold has never been in backwardation. Unlike any other commodity, all gold that has been mined throughout the ages is still out there somewhere. At an estimated 150,000 metric tons, this above-ground stock of gold— with most obvious portions in private hands or tucked away in central bank vaults— dwarfs annual production.

Unlike industrial commodities such as copper, aluminum, or zinc, where prices can go into backwardation at the slightest hint of a temporary supply disruption from major producers, contango pricing has always been the norm for gold, where futures prices exceed the spot price. Earlier this month, however, for the first time in history gold prices went into backwardation. Put differently, physical demand was to be met only by higher prices; those that held physical gold appear to be more reluctant to part with their hoard today than those who hold only promises of deliveries in the future.

Naturally, one wonders why it is that gold is now dearer in the face of what could turn out to be a potentially painful deflationary environment ahead. Historically, it is understood that the role of gold is more of a hedge against inflation. Accordingly, the usual cadres of gold bugs have been telling us that gold strength reflects the enormous sums of money that are being printed and spent to bail out failing financial institutions and to shore up the flow of credit to prevent the economy from falling ever more deeply into recession.

The inflationary implication of printing so much new fiat money is clear-cut to gold bugs; after all, Milton Friedman taught us that inflation is always and everywhere a monetary phenomenon. Most gold bugs equipped with charts showing money supply going through the roof see this as the precursor to runaway inflation ahead. The flaw with that rationale, however, is that while it is true that money supply has increased significantly and inflation is a monetary phenomenon, the velocity of money also matters. And velocity has decelerated dramatically— a natural outcome of deleveraging.

That's why I speculate that the deployment of monetary tools, including reducing the cost of credit through the Fed window to prevent deflation, is akin to 'pushing on a string'. As long as the velocity of money is decelerating, one should expect that nominal economic growth will remain at best anemic worldwide, even if the cost of credit gravitates toward zero (and for all practical purposes is there already). However, should the Fed decide to monetize debt, then inflation would become a threat.

For now though, given the subdued velocity of money, swapping financial institutions' illiquid assets for liquid Treasuries to stimulate credit flow can hardly be viewed as inflationary, and it's not even having much success yet as financial institutions appear to be hoarding liquidity. The last era of any significant period of deflation was in the 1930s. Although gold was fixed for a long time at $20.67 per ounce, in 1934 a massive devaluation of the U.S. dollar saw its fixed price jump to $35 per ounce.

During this period of 'entrenched' deflation, and in spite of the fixed price of the metal, gold proxies saw a dramatic rise in price. The NYSE-listed shares of Homestake Mining Company rose from about $4 to $500 from 1929 to 1935; the company operated for some 120 years until its flagship Homestake mine in Lead, S.D., ran out of economic reserves a few years ago and the company ceased to exist. From my perspective, we dare not expect such returns from gold producers' shares, but I remain confident that our revised target price of $1,250 per ounce (our previous target of $1,000 was met) has a reasonable probability of panning out.

That would likely result in handsome returns for gold producers' shares. The likes of Newmont Mining (NEM), Barrick (ABX), Anglogold Ashanti (AU), Gold Fields (GFI), and Agnico Eagle (AEM) would benefit in such an environment. That said, we could very well experience some deflationary forces first, before inflation (or more precisely, 'reflation') changes the course. Surely, a fast cure for deflation may simply be another major devaluation of the dollar, however unthinkable this may seem. Perhaps the following excerpt from Fed Chairman Ben Bernanke suffices as support for my take on gold prices:

"Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. "Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation."

Caveat emptor: This win-win proposition for gold is not for the faint of heart and is only speculation on my part. There is no reason to believe that the randomness of events will favor any one particular scenario. Only time will tell.

How Close Are WS And Washington?

Just How Close Are Wall Street And Washington?

By John.Crudele@NYPost.Com | 18 December 2008

We now know how Bernie Madoff invested so profitably. Will we ever know how Goldman Sachs worked its magic? I'm not suggesting that Goldman did anything akin to what Madoff allegedly pulled off— an astounding pyramid scheme that may have cost investors $50 billion and hopefully will turn out to be the grand finale for all that was evil with the investing world over the last decade.

Nope, Goldman is a perfectly legit firm that just happened to have astounding results when all the other firms in its industry were gasping for air. It has been, in fact, the envy of Wall Street for the longest time. And Goldman has a perfectly reasonable answer for its winning streak, which it has been willing to share with anyone who asked: its people were just better than anyone else at 'understanding' trends, particularly that the mortgage market was about to implode.

But, as I've mentioned in this column many times before, Goldman also happens to be incredibly well connected in Washington. This is no secret. Not only was present Treasury Secretary, Hank Paulson, once the chairman of Goldman, but so too was Robert Rubin, who served in that role in the Clinton administration and went on to Citigroup.

Goldman alums, in fact, are sprinkled throughout high levels of government. And I'm sure that these folks are the most honest people Wall Street has ever known. They are, no doubt, a national treasure. Yet, there are lingering questions that the Bush administration, and Paulson in particular, need to answer before they leave office and are sucked into that profitable world of book writing, lecturing and board sitting.

During an interview on CNBC on Aug. 21, 2007, for instance, Paulson said, "I think it's my job to talk regularly with market participants, but also talk regularly to key regulators and make sure that we are seeing the same issues, the same problems and working towards the same solutions." Fine, the Treasury secretary is allowed to talk with regulators all he wants. But, as I asked back then, what did Paulson mean when he said that he was talking with "market participants?"

Did that mean he might have been conveying— even accidentally— sensitive information to people who could profit from it? Maybe even with people from his old firm? And did he really think this was his "job" as Treasury secretary? In particular, I asked whether Paulson felt it was necessary to share information with market participants about an impending interest-rate cut— the first in this series— that he may have learned about during a lunch with Federal Reserve Chairman Ben Bernanke on Aug. 16.

The stock market erased most of a 300-point loss that day. And that was back when reversals of that magnitude were unheard of and big drops were far from ordinary. A long time ago, The Post requested the minutes of meetings held by the President's Working Group on Financial Markets [[aka, the 'Plunge Protection Team' or 'PPT': normxxx]], a secretive team that Paulson headed and often spoke of before the last election.

Since the new president was picked, however, there have been hardly any references to the Working Group even though the financial crisis has been intensifying. We've gotten nothing in response to our requests. Goldman [reported] a huge quarterly deficit today. And I'm sorry for its loss.

But I wouldn't be doing my job unless I asked again: What were the connections between Washington, Wall Street firms and Goldman in particular, during the last decade? If journalists and regulators had asked more questions back then maybe some of this shocking stuff wouldn't be happening today.

The Federal Reserve [met] today and all I can say is: Forget the interest rate cuts.

Ben Bernanke's gang [was] expected to reduce the federal funds rate by 0.50% to 0.75% [it was actually 0% - 0.25%]. The Fed, of course, [surprised] the financial markets.

But the funds rate— at which banks lend to each other— is already [effectively] near zero [it was already at the 0% - 0.25% rate, in fact] and has been for some time. This rate is irrelevant anyway since any bank that needs money only has to ask Washington. The problem with cutting interest rates— and this will be the 10th time in little over two years— is that the policy is having unintended consequences, as well as being ineffective.

The dollar has been declining in value since mid-November. [[Not undesirable from BB & Company's point of view.: normxxx]]

The Fed has been engaging in a frightening policy of money printing. And if that isn't enough to scare off foreign investors, the losses created outside this country by Bernie Madoff's alleged pyramid scheme certainly will. As I've been warning for a long time, foreigners could decide that investing in the US is just too risky. And then interest rates here will climb rapidly [[unless, of course, BB and Company start buying LT USTs hand over fist, as he has "threatened" to do!: normxxx]]

Why Are These GOP Senators Unhappy?

Why Are These GOP Senators Unhappy With Auto Aid?
Rescue Opponents Want More UAW Sacrifices

By Todd Spangler and Justin Hyde | 16 December 2008

WASHINGTON— Over the last decade, the UAW has spent more than $10 million to elect Democrats and defeat Republicans— some of them the same GOP senators now being asked to rescue the domestic auto industry. Those Republican senators, who may hold the key to getting the $14-billion lifeline to General Motors Corp. and Chrysler LLC passed through Congress, are clamoring for deeper union concessions as a condition of any kind of support.

Sens. Richard Shelby of Alabama, Bob Corker of Tennessee and Minority Leader Mitch McConnell of Kentucky represent states where foreign automakers have significant operations and the UAW has less sway than in Michigan or Ohio. Each also has been the target of considerable political support from the automakers' union flowing to Democrats who have opposed the senators in elections.

Complicating matters for the union— which has been lobbying hard for passage of the rescue plan— is that it threw its political weight behind many of the Democratic opponents who managed to beat Republican incumbents last month. Now those same defeated GOP senators are being asked to save the domestic auto industry from ruination before giving up their seats. In this year's elections, the UAW gave $40,000, for instance, to six Democrats who won seats currently occupied by Republicans.

On Wednesday, Shelby— who once was a Democrat but now leads the forces lining up against the automakers in the Senate— said the most recently unveiled legislation reveals "the influence of the UAW," as it calls for no specific cuts in health care benefits or wages. Corker, meanwhile, has demanded that the union accept wage cuts that put it on an even keel with nonunion plants in the South, a provision even the Bush administration didn't insist upon as a condition to passage.

"Here's the tension," Deputy White House Chief of Staff Joel Kaplan said Wednesday. "A lot of people would like us to write the concessions into the legislation: The unions must take exactly this pay cut. ... That's not something we believe that the Congress is best suited to do."

Foreign Automakers

Against that background is the fact that Shelby, Corker, McConnell and others represent states where foreign automakers have a presence. Alabama is home to plants for Mercedes-Benz, Honda, Hyundai and Toyota. Tennessee is getting a new Volkswagen plant and is home to Nissan's North American headquarters and other manufacturing facilities. Georgetown, Ky., in McConnell's home state, is the site of Toyota's biggest plant outside Japan.

Sen. George Voinovich, R-Ohio, a supporter of the auto industry rescue plan, said he's still waiting for specifics on what the legislation's critics are demanding. "I think it's antiunion. I think that's the motivation behind it," said Mike Kennedy, 44, of Warren, a member of UAW Local 961 who works at Chrysler's Detroit Axle plant on Lynch Road. "They want us to file for bankruptcy so they can walk away from their obligations."

Kennedy said he's hearing a lot of anger toward Southern senators among rank-and-file members, likening it to a civil war ready to break out again, North against South. Messages left with some of the GOP senators' offices asking if campaign contributions played any role in their decision-making were not returned Wednesday.

Support For The Union

On the other side of the aisle, many Democrats said the union already has made more than its share of concessions— on wages, health care and more— during recent contract negotiations. Also, the UAW has signaled it would be willing to suspend its controversial jobs bank, which allows laid-off workers to continue to receive nearly full pay for up to two years.

The union also has argued vigorously that once you drop legacy costs to fund health care and pensions for retirees from the equation, line workers don't make much more than their counterparts at the foreign automakers' U.S. plants. In a best-case scenario, Ford Motor Co. presented information to Congress last week saying there was only a $4-per-hour difference between workers at Detroit Three plants and those operated in the United States by foreign-based companies.

Rep. Barney Frank, D-Mass., who chairs the House Financial Services Committee, said there appeared to be a double standard on the part of Republicans focusing on autoworkers' pay, when they voiced no similar concerns about employee wages or benefits before approving a $700-billion bailout for the financial industry.

"The average worker at AIG makes far more money than an autoworker. The average worker at Citigroup ... makes more than an autoworker," Frank said Wednesday. "Does anybody remember Citigroup being told that as a condition of its money, they have to get no more than a community banker gets?"

[ Normxxx Here:  And the banks, recipients of several hundred $billions directly and several $TRillions indirectly are reluctant to make any new loans to the automakers to "tide them over." Moreover, they are just as reluctant to make new loans to prospective car buyers.  ]

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Anni Horribili-- 2008-2009

Annus Horribilis Peaks In Anxiety For Global Economy

By Rich Miller and Simon Kennedy | 15 December 2008

Dec. 15 (Bloomberg)— This was the year the global economy fell apart. Next year may not be that much better, as policy makers try to put the pieces back together[!?!] [[I think he means, continue to put fingers in the dike to keep it from collapsing. Trying "to put the pieces back together" is still a ways off yet!: normxxx]] All the bulwarks crumbled: Investment banks went bust and credit evaporated. U.S. consumer spending crashed, pushing Detroit automakers to the brink of bankruptcy. And growth in China and other emerging markets nosedived. The world economy has "suffered a cardiac arrest," says Mohammed El-Erian, co-chief executive officer of Pacific Investment Management Co., the Newport Beach, California-based manager of the world’s biggest bond fund. The damage is so immense and widespread, the most that central banks and governments can hope for next year may be to stop further deterioration and set the stage for recovery in 2010. Failure may heighten the danger of deflation and near-depression.

"We will be very lucky if we reach the bottom in 2009," Harvard University professor Martin Feldstein said in a Bloomberg Radio interview Dec. 9. The trouble is that policy makers have already taken significant steps to combat the crisis— from cutting interest rates at an historic pace to committing hundreds of billions [[TRillions, actually: normxxx]] of dollars to battered banks. So far, they’ve failed to quell the turbulence in the markets or turn their economies around.

That’s prompting officials to dig deeper into their 'tool' boxes. Investors are betting that Federal Reserve Chairman Ben S. Bernanke and his colleagues will cut the overnight interest-rate target to a record-low 0.5 percent or less at a two-day meeting that began today. The Fed may also discuss other unorthodox measures beyond rate cuts, such as buying [[longer term: normxxx]] Treasury securities, to get credit flowing.

Pushing The Limits

With monetary policy pushing the limits of what the central bank can do, incoming President Barack Obama pledges "the single largest new investment" in roads, bridges and public buildings since Dwight D. Eisenhower’s administration a half-century ago, in a bid to trigger growth and create jobs. The government is essentially trying to save capitalism from the capitalists— something that can’t be accomplished quickly. After piling into risky assets, from subprime mortgages to junk bonds, investors and financial institutions have turned tail and are reluctant to lend even to creditworthy borrowers.

"The financial markets have frozen up entirely," says Barry Eichengreen, an economics professor at the University of California at Berkeley.

Breakdown Trigger

The trigger for the breakdown was the bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 [[which egregious error should be chiselled on Hank Paulson's tombstone: normxxx]]. The decision by Treasury Secretary Henry Paulson and Bernanke to allow Lehman to fail— after rescuing Bear Stearns Cos. and mortgage lenders Fannie Mae and Freddie Mac— shocked investors and financial firms and led to an abrupt contraction of credit worldwide [[and probably the worst six weeks in the credit and stock markets on record, as Wall Street vainly tried to "disentangle" Lwehman's many financial commitments and obligations: normxxx]].

That has left governments and central banks to fill the hole by investing capital in banks and guaranteeing their liabilities, and in the U.S., providing a backstop to the $1.7 trillion commercial-paper market companies rely on for daily funding. "Letting Lehman fail was supposed to restore market discipline by showing that not all large firms would be saved," says Dino Kos, a former senior Fed official and now a managing director at Portales Partners in New York. "Paradoxically, since Lehman, everybody has been bailed out, everybody has been 'saved' or merged out of existence with taxpayer help."

Abrupt Shift

The abrupt shift from greed to fear has turned the economy on its head. The U.S. Treasury last week sold four-week bills at an effective zero-percent interest rate— even as it announced that the government’s budget deficit swelled to a record $401.6 billion in the first two months of this fiscal year. The U.S. stock market has plummeted, wiping out $7.6 trillion of investor wealth, with the Dow Jones Wilshire 5000 index dropping 44 percent from a record high in October 2007. Other markets have also fared badly, with the MSCI World Index of stocks in 23 developed countries down 47 percent.

John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, likens watching the markets to viewing the iconic shower scene in Alfred Hitchcock’s "Psycho" when the heroine gets knifed to death. "You could almost hear the soundtrack of screeching violins during televised financial news— but this time it was your assets that were going down the drain," Silvia says.

Writedowns And Losses

Much of the financial-services industry followed. Institutions worldwide have recorded almost $705 billion in writedowns and credit losses so far this year and have announced 217,070 job cuts. Highly leveraged investment banks disappeared, some into mergers, after investors pummeled their shares. "There’s no more Wall Street," Alan "Ace" Greenberg, former chief executive officer of Bear Stearns, said in a Dec. 8 Bloomberg Television interview. "That model just doesn’t work." [[Well, there are no more investment banks; but Wall Street's still there— and, in the goodness of time, will scheme again to the detriment of all but a few.: normxxx]]

On Main Street, inflation fears have given way to worries about deflation— a broad and sustained decline in prices and wages— as global growth collapses and commodity prices tumble. Unemployment in the U.S. is surging, with employers cutting payrolls at the fastest pace in 34 years last month.

Talk about a depression is no longer dismissed out of hand, though most economists still consider one highly unlikely. While there’s no technical definition of what makes a depression, New York University economic historian Richard Sylla says it would take a U.S. unemployment rate of 10 percent or more for longer than a year. The rate now is at 6.7 percent [[actually at around 16%, using pre-Clintonian calculations: normxxx]], well below[!?!] the Great Depression peak of almost 25 percent.

Restoring Growth

"We won’t get the contraction for a great depression," says Simon Johnson, former chief economist for the International Monetary Fund who’s now at the Peterson Institute for International Economics in Washington. "We know enough to avoid that[!?!], but we don’t know nearly enough about getting growth back." The Fed’s ability to gun growth is constrained by what economists call a liquidity trap: Banks are hoarding cash even with rates near zero, and consumers and companies are too shell-shocked to borrow.

"We’ve got an economy that is in deep trouble and the Fed has lost traction," says Princeton University Professor Paul Krugman, who won this year’s Nobel Prize for economics.

That is pushing the Fed toward unconventional policies similar to the so-called 'quantitative-easing' strategy Japan used to fight deflation in the early part of this decade. Bernanke said Dec. 1 the Fed may begin buying Treasury securities in a bid to revive the economy by lowering longer-term interest rates. Another option is a public 'promise' to keep short-term rates low for an extended time.

Upending Thesis

The U.S. has exported its woes, complicating the task of reviving growth and upending the thesis of a year ago that other countries would become more independent of the world’s largest economy. Recession now plagues nations from the U.K. to Japan, forcing central banks to follow the Fed toward zero rates. JPMorgan Chase & Co. economists expect benchmark rates in every industrial country to be at 1 percent or less in a year.

Emerging markets early dashed hopes that they would serve as an alternative source of economic power as the industrial nations economies shrink. Chinese industrial production grew in November at its weakest pace in nine years, a report showed today. The IMF is also busy again, lending more in November than it did in the past five years combined, to economies as diverse as Iceland and Pakistan.

Weakest Stretch

Morgan Stanley economists last week cut their outlook for global growth to 0.9 percent next year and 3.3 percent in 2010. That would be the second-weakest two-year stretch since World War II, barely better than the downturn of the early 1980s. [[Anything less than world population growth— 3%— is considered recession.: normxxx]]

Marco Annunziata, chief economist at UniCredit MIB in London, expects "the worst growth figures in many years." He says that "2008 has been the Annus Horribilis for markets, and 2009 is shaping up to be the Annus Horribilis for the economy." Queen Elizabeth II famously used this term— which means horrible year in Latin— to describe 1992, when Windsor Castle was damaged by fire and the marriages of three of her children failed.

Richard Berner, Morgan Stanley’s co-chief economist in New York, says the risk is that policy makers elsewhere lag behind those in the U.S. in coming to the rescue. European Central Bank Executive Board member Juergen Stark said last week that any further reduction in interest rates in the euro-area may be "small" after the bank eased its main refinancing rate this month by 75 basis points to 2.5 percent— the most in its 10-year history.

Steep Decline

Central bankers in some emerging markets remain concerned about inflation, following a steep decline in their countries’ currencies. Brazil’s central bank left its interest rate unchanged at a two-year high of 13.75 percent last week, though it signaled it may be ready to ease next year. On the fiscal front, UBS AG economists calculate a global stimulus of 1.5 percent of gross domestic product has so far been lined up for next year. That’s still short of the more than 2 percent recommended by the IMF.

Germany is resisting demands to spur growth as Chancellor Angela Merkel refuses to bust a budget that will be in balance in 2008 for the first time in 39 years. Raghuram Rajan, a former IMF chief economist and now a University of Chicago professor and adviser to Indian Prime Minister Manmohan Singh, sees an added danger: The steep slowdown in global growth tempts countries into protectionism, the kind of beggar-thy-neighbor approach that helped lead to the Great Depression.

Shrinking Trade

International trade will shrink in 2009 for the first time in more than 25 years, the World Bank said Dec. 9. It sees world trade volumes contracting 2.1 percent next year after growing at an average annual rate of 7.8 percent the last three years. "We’re facing a once-in-a-century problem," says Harvard University professor and former IMF chief economist Kenneth Rogoff. "The global scale and magnitude of it is much greater than those we’ve seen before."

"We’re going to face a deep downturn and slow recovery no matter what we do. The challenge now is to contain it to a couple of years and not a decade."

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

The Next 10 Years... UP!

The Next 10 Years Should Be Very Good To Stocks

By Dr. Steve Sjuggerud | 12 December 2008

"The stock market is presenting you with one of the great buying opportunities of your lifetime— perhaps the greatest. Stop trying to pick the bottom." That's what 41-year market veteran Steve Leuthold, of the Leuthold Group, just told his clients. "The most difficult decision is not what to buy," he says. "Just buy!"

Leuthold is one of our favorites, primarily because he doesn't follow the crowd... even when it's to the detriment of his own business. For example, for much of the last decade, he's been bearish on stocks. Clients don't line up to give you money when you're bearish. But Steve launched the Leuthold Grizzly Fund in June 2000, near the top of the stock market bubble. The Grizzly Fund is up nearly 80% this year.

He was right to be bearish this decade. As he told his clients, stocks lost as much over the last 10 years as they did from 1929 to 1939, which was "the worst 10-year performance in U.S. stock market history." That's not the only big, contrarian call Leuthold has been right on...

Back in 1980, when inflation and interest rates were running in the mid-teens, Leuthold went against the crowd. He predicted interest rates and inflation would fall to 5% and 3%, respectively. He was so confident in his idea in 1980, he literally wrote the book on it: The Myths of Inflation and Investing. And he was right.

Leuthold is now extremely bullish: "With your personal funds, this will prove to be a great time to buy an index fund (Lord, forgive me), locking it up for ten years."

Why 10 years? Here's what Leuthold discovered: Every time the stock market has been down for a 10-year period (as over the last 10 years), stocks followed that loss with at least a triple-digit percentage increase over the next 10 years. The market has already priced in the next Great Depression. If that doesn't arrive (and we don't expect it to), stocks will soar.

In short, this is not a time to get out of stocks. This is a time to get into of stocks. According to Leuthold, it doesn't matter what you buy. As he suggested, you could hardly go wrong with an index fund.

But if you're looking for a specific stock idea, how about shares of Warren Buffett's Berkshire Hathaway? On November 20, the stock traded below its most-recently stated book value. By my numbers, the last time it did this was back in 1984. The stock nearly doubled a year later.

It's fallen close to book value a few other times: in August 1982, when it doubled in a year. Then again during the 1987 crash... and it soared over 50% a year later. Finally, in March 2000, when the stock jumped by over 50% by the end of that year.

Last month, I told readers of True Wealth to watch for an uptrend before buying Berkshire. Well, the stock hit our "buy" price a few weeks ago... And it's up 13% already. You don't need to get the timing exactly right. Leuthold says it's time to buy for the next decade...

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Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Make A Fortune In 2009

This Trade Will Make You A Fortune In 2009
Click here for a link to complete article:

By Porter Stansberry | 13 December 2008

As anyone who has read my monthly advisory (or this DailyWealth issue) knows, I believe the current financial mess will last much longer than anyone thinks. That's why I believe it's going to be an extraordinarily profitable time for people who are on the right side of several huge trends. One of the biggest trends you need to be positioned for is the collapse of poorly collateralized and highly indebted assets.

There are several obvious and large categories of these kinds of assets. The first is highly leveraged real estate investment trusts (REITs). These corporate structures are truly designed to fail. In order to qualify for their tax benefits (they aren't taxed at the corporate level), REITs must pay out 90% of their earnings.

Thus, to grow, they must either borrow heavily or sell additional equity. Selling equity isn't popular. It "dilutes" current shareholders. So many of these firms end up piling on debt.

If they happened to have made any large acquisitions in the last two years, they're cooked. They can't extend their debt maturities because they overpaid for the assets, which are no longer good collateral. And they can't repay the loans because they don't keep much cash.

Another sector chronically short of capital is airlines. Airlines are, generally speaking, perfectly hedged. They lose money in every market. When times are good, fuel costs kill them. When times are bad, they get killed because of empty seats. Meanwhile, the only way to make any money in such a capital-intensive business is to use lots of debt financing.

When I went looking for heavily indebted companies that can barely afford their debt service, I found a collection of commercial property firms, airlines, and casinos. A few of the highlights are in the table below. You'll find the amount of income these companies made from their operations in 2007 versus their interest costs, along with how much debt they owe in excess of their equity.

Name Symbol Market Cap in Millions Interest to Income (2007) Debt to Equity Maguire MPG  $83 144% 43.8 JetBlue JBLU  $1,400 108% 2.4 Macerich MAC  $1,000 98% 4.3 Wendy's WEN  $2,000 94% 2.0 Post PPS  $730 76% 1.0 Cousins CUZ  $656 72% 1.7 SL Green SLG  $1,200 67% 1.5 Continental CAL  $1,500 51% 5.4 MGM MGM  $3,000 50% 13.2 UDR UDR  $179 47% 2.3 CB Rich. CBG  $800 24% 3.2

Take mall operator Macerich, for example. The stock is still worth $1 billion, even though the company has outstanding debts four times larger than the equity on its balance sheet and it spent 98% of what it earned in 2007 on interest. Imagine if you owed debts four times greater than your net worth and 98% of everything you earned had to be paid in interest on your mortgage. What kind of bank would lend you any more money?

This Is One Of The Great Buying Opportunities Of The Last 30 Years

I'm confident all of these companies will either go bankrupt or suffer an equivalent massive dilution in order to restructure their balance sheets. I don't think debt financing will be available in the next decade for firms with this much leverage. The debt-centric business model is, quite simply, dead.

Even though I'm sure all of these companies will see their shareholders wiped out, when it comes to shorting stocks, I prefer to have a huge margin of safety. I only want to short companies whose balance sheets and business models are so hopelessly bad that nothing, not even a Christmas miracle, could possibly save them. Why short companies with a 95% chance of going bust when you can short companies 100% certain to go bust?

One idea I encourage you investigate is the pending collapse of deeply indebted homebuilding stocks. If you look at Pulte, Centex, KB Home, D.R. Horton, and Toll Brothers, they all owe around $3 billion. They are unlikely to repay these loans. Already roughly one in 10 mortgage holders is in default. This number will continue to rise as unemployment grows and as more adjustable-rate mortgages reset.

Even if this mortgage crisis is somehow resolved, demand for housing is likely to be extremely depressed for a long time as people will be reluctant to lend or borrow large amounts. It's hard to believe there will be any profitable way to build new homes for at least the next two or three years— and perhaps longer. That means bankruptcy for some of the country's biggest homebuilders.

  M O R E. . .

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Spending Slump Paces ‘scary’ U.S. Recession

Worsening Spending Slump Paces ‘scary’ U.S. Recession

By Shobhana Chandra and Andy Burt | 12 December 2008

Dec. 10 (Bloomberg)— The biggest slump in U.S. consumer spending since 1942 will extend the recession and push the jobless rate to the highest level in a quarter century, according to economists surveyed by Bloomberg News. Household spending will drop 1 percent in 2009, the biggest decline since after the attack on Pearl Harbor, according to the median estimate of 51 economists surveyed Dec. 4 through Dec. 9 [[and, remember, these guys generally err on the positive side: normxxx]]. By the middle of next year, the economy will have shrunk for a record four consecutive quarters, the survey showed. "That sounds scary enough to me," said Jeffrey Frankel, an economics professor at Harvard University and a member of the group that determined the start of the recession. "Consumers have carried the weight of expanding demand for a long time at the expense of a serious deterioration of their balance sheets."

A drop in spending has brought the auto industry to the brink of collapse, and mounting unemployment, a lack of credit, and falling property and stock values will prompt Americans to turn even more frugal. President-elect Barack Obama has pledged to pursue the biggest public-works plan since the 1950s to stem the already year-old economic slump. "It’s a serious recession, and there’s a good chance it will break the 16-month record since the Depression," said James O’Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. "We’re at the stage where the weakness is feeding on itself. The next few months look pretty rough."

Longest Slumps

The National Bureau of Economic Research last week announced the U.S. contraction began in December 2007. The longest economic slumps since 1945 were the 16-month downturns that ended in March 1975 and November 1982. The Great Depression lasted 43 months, from August 1929 to March 1933. A report from the Commerce Department today showed wholesale inventories fell 1.1 percent in October, the most in seven years, as a record 4.1 percent drop in sales caused companies to scale back.

Economists in the survey cut fourth-quarter forecasts for gross domestic product by more than a percentage point from last month, predicting the economy will shrink at a 4.3 percent annual rate, the biggest plunge since 1982. The world’s largest economy will contract at a 2.4 percent pace in the first three months of 2009 and at a 0.5 percent rate the following quarter, the survey showed. Combined with the 0.5 percent drop in this year’s third quarter, it would be the longest slide since quarterly records began in 1947.

Consecutive Declines

Consumer purchases, the biggest part of the economy, may drop at a 4 percent rate this quarter, the survey showed. Following the 3.7 percent slump from July through September, it would be the first time on record that spending declined in excess of 3 percent in consecutive quarters. The spending slump will continue into the first half of 2009, according to economists.

The drop in sales will prompt employers to keep cutting staff, sending the unemployment rate to 8.2 percent by the end of next year, a 25-year high, the survey showed. "It’s the perfect storm for the consumer," said Peter Kretzmer, a senior economist at Bank of America Corp. in New York. "With rising unemployment, we’re talking about a very serious recession. If credit conditions don’t ease, it’s difficult to see the recession ending soon."

Investors concerned about the worst financial crisis in at least 70 years have rushed to the safety of U.S. government debt, causing three-month Treasury bills to trade yesterday at negative rates for the first time. Treasuries fell today, snapping the rally, on concern the need to fund the financial rescue plans will flood the market with debt.

Rate Cut

Economists project the Federal Reserve will cut the benchmark rate target to 0.5 percent when they meet in Washington next week and hold it there for all of 2009, the survey showed. "The Fed is moving aggressively and will continue to do more," UBS’ O’Sullivan said. Stimulus measures from the central bank and the government are "absolutely needed," he said.

Automakers are among those seeking help. Congress may vote as early as today on a $15 billion plan Democrats reached with the Bush administration to keep automakers afloat that includes proposals to restructure the industry. General Motors Corp. and Chrysler LLC say they need aid to survive.

Retailers also are concerned about the November-December holiday season, which brings in one-third or more of annual revenue and is predicted to be the worst in years.

No Bottom

"The big problem is that there’s no bottom in sight for consumers and for businesses," said John Lonski, chief economist at Moody’s Capital Markets Group in New York. "The negative sentiment makes it difficult to stabilize the situation. It’s very worrisome."

Businesses are pulling back as Americans retrench. Dow Chemical Co., the largest U.S. chemical maker, this week said it will cut 5,000 jobs, permanently shut 20 facilities, temporarily idle 180 plants and reduce the company’s contractor workforce by about 6,000. "The entire industrial supply chain all the way to whatever the consumer buys outside of food and health is in a recessionary mode," Chief Executive Officer Andrew Liveris said on a conference call. "Across the board, everywhere."

The downturn will help contain inflation, the survey showed. Consumer prices will rise 1.6 percent this year and next, the smallest back-to-back gain since 1964-65, according to the median. It’s "a recession with adjectives," Martin Feldstein, a member of the NBER group that announced the downturn, said in a Bloomberg Television interview yesterday. "A deep recession, a long recession, a damaging recession."

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Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Driving To Hell

An Adequate Way To Drive To Hell

By Jeremy Clarkson,The Sunday Times,UK | 12 December 2008

From an automotive reviewer in the UK. Slightly edited.

I was in Dublin last weekend, and had a very real sense I’d been invited to the last days of the Roman empire. As far as I could work out, everyone had a Rolls-Royce Phantom and a coat made from something that’s now extinct. And then there were the women. Wow. Not that long ago every girl on the Emerald Isle had a face the colour of straw and orange hair. Now it’s the other way around.

Everyone appeared to be drunk on naked hedonism. I’ve never seen so much jus being drizzled onto so many improbable things, none of which was potted herring. It was like Barcelona but with beer. And as I careered from bar to bar all I could think was: "Jesus. Can’t they see what’s coming?"

Ireland is tiny. Its population is smaller than New Zealand’s, so how could the Irish ever have generated the cash for so many trips to the hairdressers, so many lobsters and so many Rollers? And how, now, as they become the first country in Europe to go officially into recession, can they not see the financial meteorite coming? Why are they not all at home, singing mournful songs?

It’s the same story on this side of the Irish Sea in the UK, of course. We’re all still plunging hither and thither, guzzling wine and wondering what preposterously expensive electronic toys the children will want to smash on Christmas morning this year. We can’t see the meteorite coming either.

I think mainly this is because the government is not telling us the truth. It’s painting Gordon Brown as a global economic messiah and fiddling about with VAT, pretending that the coming recession will be bad. But that it can deal with it.

I don’t think they can. I have spoken to a couple of pretty senior bankers in the past couple of weeks and their story is rather different. They don’t refer to the looming problems as being like 1992 or even 1929. They talk about a total financial meltdown. They talk about the End of Days.

Already we are seeing household names disappearing from the high street and with them will go the suppliers whose names have only ever been visible behind the grime on motorway vans. The job losses will mount. And mount. And mount. And as they climb, the bad debt will put even more pressure on the banks until every single one of them stutters and fails.

The European banks took one hell of a battering when things went wrong as far away as America. Imagine, then, how life will be when the crisis fully arrives on this side of the Atlantic. Small wonder one City figure of my acquaintance ordered three safes for his London house just last week.

Of course, you may imagine the government will simply step in and nationalise everything, but to do that, it will have to borrow. And when every government is doing the same thing, there simply won’t be enough cash in the global pot. You can forget Iceland. From what I gather, Spain has had it. Along with Italy, Ireland and very possibly the UK.

It is impossible for someone who scored an Unsatisfactory in his economics A-level to grapple with the consequences of all this but I’m told that in simple terms money will cease to function as a meaningful commodity. The binary dots and dashes that fuel the entire system will flicker and die. And without money there will be no business. No means of selling goods. No means of transporting them. No means of making them in the first place even. That’s why another friend of mine has recently sold his London house and bought somewhere in the country… with a kitchen garden and a well.

These, as I see them, are the facts. Planet Earth thought it had £10. But it turns out we had only £2. Which means everyone must lose 80% of their wealth. And that’s going to be a problem if you were living on the breadline beforehand.

Eventually, of course, the system will reboot itself, but for a while there will be absolute chaos: riots, lynchings, starvation. It’ll be a world without power or fuel or fertiliser, and with no fuel or fertiliser there’s no way the modern agricultural system can be maintained. Which means there will be no food either. You might like to stop and think about that for a while.

I have, and as a result I can see the day when I will have to shoot some of my neighbours— maybe even David Cameron— as we fight for the last bar of Fry’s Turkish Delight in the smoking ruin that was Chipping Norton’s post office.

I believe the government knows this is a distinct possibility and that it might happen next year, and there is absolutely nothing they can do to stop Cameron getting both barrels from my Beretta. But instead of telling us straight, they call the crisis the "credit crunch" to make it sound like a breakfast cereal and they ask Alistair Darling to smile more when he’s being interviewed. I can’t say I blame them, really.

If an enormous meteorite was heading our way and the authorities knew it couldn’t be stopped or diverted, why bother telling anyone? Best to let us soldier on in the dark until it all goes dark for real. Think about the plight of the American automobile manufacturers.

Behold the new Insignia, which has been voted European car of the year for 2009. This award is made by motoring journalists across Europe, and, with the best will in the world, the Swedes do not want the same thing from a car as the Greeks. That’s why they almost always get it wrong. They’ve got the Insignia even more wrong than usual because the absolutely last thing anyone wants right now, and I’m including in the list consumption, a severed artery and a massive shark bite, is a four-door [sedan] car with a bargain-basement badge.

Oh it’s not a bad car. It’s extremely good-looking, it appears to be very well made, it is spacious and the prices are reasonable. But set against that are seats that are far too hard, the visibility— you can’t see the corners of the car from the driver’s chair— and the solid, inescapable fact that the Ford Mondeo is a more joyful thing to drive.

I feel, I really do, for the bosses at GM who’ve laboured so hard to make a decent car for Europeans. Their latest effort is way better than the Vectra. It looks as though they were bothered. But asking their dealerships to sell such a thing in today’s world is a bit like asking men in the first world war trenches to charge the enemy’s machinegun nests with spears.

Right now, there are two paths you can go down. You can either adopt the Irish attitude to the impending catastrophe and party like it’s 1999. In which case you are better off ignoring the Vauxhall and buying a 24ft Donzi speedboat instead. Or you can actually start to make some sensible preparations for the complete breakdown in society. In which case you don’t want a Vauxhall either.

Better to spend the money on a pair of shotguns and an allotment.

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Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Outlook Darkens; Recession Deepens

Outlook Darkens As Recession Deepens
Economists Forecast Lengthiest Downturn Since Great Depression

By Phil Izzo, WSJ | 11 December 2008

The current recession may turn out to be the longest and most painful downturn since the Great Depression, according to economists in the latest Wall Street Journal economic-forecasting survey. The 54 economists who participate in the survey, on average, forecast quarterly contractions in gross domestic product for the current quarter and the first two periods of 2009. The Commerce Department's preliminary estimate showed a 0.5% decline in quarterly GDP for the third quarter. If the economists' predictions bear out, it would mark the first time GDP has contracted in four consecutive quarters during the postwar period. On average, economists expect the downturn to conclude in June 2009. Last week, the National Bureau of Economic Research dated the start of recession in December 2007. That puts the downturn at 18 months, the longest period of decline since the Great Depression. The recessions of 1973-75 and 1981-82 both lasted 16 months. Charts and Full Results

"For the household sector, this will be the worst event we've had in the post-World War II period," said Bruce Kasman of J.P. Morgan Chase & Co. "The downturn would be deeper still, in our view, were it not for an ultra-aggressive combination of monetary and fiscal stimulus that will soon move into high gear," Morgan Stanley economists Richard Berner and David Greenlaw said in a research note. Authorities are pulling out all the stops: Quantitative easing by the Fed and the largest-ever fiscal stimulus package likely will promote stability in the economy late in 2009 and a moderate recovery in 2010."

Many economists cited a major expected fiscal-stimulus package as the key to pulling the U.S. out of recession. Details about the government intervention remain unclear. "The precise date is likely to depend on timing of the stimulus package," said Lou Crandall of Wrightson ICAP.

Even with specifics of the stimulus uncertain, the economists expressed confidence in U.S. President-elect Barack Obama's economic team. Nearly half of respondents said the incoming policy makers are significantly better than their counterparts in the Bush administration, and a quarter said the new team is slightly better. Just 10% favored the departing officials.

The lack of confidence was clear in the economists' grades for Treasury Secretary Henry Paulson, whose marks fell to a 60, the lowest level during his tenure. More than half of respondents gave the Treasury secretary a grade equivalent to a D or F. Federal Reserve Chairman Ben Bernanke's average grade rose slightly to a 72, but 26% gave him the equivalent of a D or F. More than half of economists put his grade in the A or B range.

The length of a downturn can be measured against earlier recessions, but its intensity is harder to quantify and compare. "History never really repeats itself," said Stuart Hoffman of PNC Financial Services Group. "It's difficult to say that this is the worst recession in the postwar period."

Adding in the economists' forecasts, a tally of the change in GDP from the beginning to the end of the recession puts the decline at slightly more than 1% overall. Periods of growth in early 2008 offset some of the expected weakness this year and next. That makes the current recession deeper than those in the 1990s and in early this century, but it doesn't reach lows seen in the 1970s and 1980s.

"Recessions that tended to be the deepest were sparked by events that caught the business sector off guard," said Mr. Kasman, who notes that corporate profits aren't likely to be hit as hard as past recessions. "This event had a prelude. Therefore, the intensity of the event is being smoothed out over a longer period of time."

This recession has centered not on businesses but consumers, who are being hit by dwindling home prices and job losses. [[And maxed out credit cards.: normxxx]] The economists on average said the unemployment rate will peak at 8.4% in response to this recession. While that actual rate was surpassed in both the 1970s and 1980s, it would mark a four-percentage-point increase from the low of 4.4% in March 2007. Only the 1973-75 recession, with a 4.1-percentage-point increase, had a larger jump in the postwar period.

About The Survey

The Wall Street Journal surveys a group of 55 economists throughout the year. Broad surveys on more than 10 major economic indicators are conducted every month. Once a year, economists are ranked on how well their forecasts have fared. For prior installments of the surveys, see: WSJ.com/Economist.

Adding to consumers' pain is that the end of the recession isn't likely to mark the end of job losses. In past recessions, labor-market contraction continued for months after a downturn's official end. So, while economists, on average, expect the unemployment rate to top out at 8.4%, they forecast an 8.1% rate for December 2009 as job cuts continue into 2010.

"The job market is ugly and is going to stay that way," said Allen Sinai at Decision Economics. "The economy is going through the heart of reductions in the work force now." This scenario creates problems for the Fed, as it seeks to fulfill part of its dual mandate to control inflation and support growth.

The challenge is compounded by an effective federal-funds rate that is already close to 0%, offering the central bank little room to use its most powerful policy tool. The nominal rate now stands at 1%, and economists expect a half-percentage-point cut to 0.5% at next week's rate-setting meeting. On average, they expect the rate to stay at 0.5% through June 2009.

That doesn't mean the Fed is out of options. When asked what the Fed's most useful remaining tool is, more than one in four economists said the central bank should target long-term interest rates, by actions such as buying Treasurys. Among the economists, 23% said the Fed should backstop specific markets, similar to its moves in commercial paper. Thirteen percent said the Fed should expand lending facilities further, and 8% said the central bank should commit to keeping rates low for an extended period. However, the plurality of the economists chose "other"— with most saying the Fed needs to use a combination of the options.

One concern that has moved to the wayside is inflation— the other part of the central bank's mandate. The economists expect consumer prices to be flat on a year-over-year basis in June 2009, before rising slightly to a 1.2% annual gain by next December. "Unless the Fed turns the tide fast, inflation is not a concern," Mr. Kasman said.

[ Normxxx Here:  While I am sure that all of these 'experts' hold advanced degrees, nevertheless, none of them noted that comparing those pre-Clinton and post-Clinton statistics on GDP and unemployment is like comparing apples and oranges. No wonder they are nearly always wrong.  ]

ߧ

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Fear Triggers Gold Shortage

Fear Triggers Gold Shortage, Drives Us Treasury Yields Below Zero

By Ambrose Evans-Pritchard, Telegraph, UK | 11 December 2008

Investors search for safe places to store wealth as the financial crisis shakes faith in the system has caused extraordinary moves in global markets over recent days, driving the yield on 3-month US Treasuries below zero and causing a rush for physical holdings of gold. "It is sheer unmitigated fear: even institutions are looking for mattresses to put their money until the end of the year," said Marc Ostwald, a bond expert at Insinger de Beaufort.

The rush for the safety of US Treasury debt is playing havoc with America's $7 trillion "repo" market used to manage liquidity. Fund managers are hoovering up any safe asset they can find because they do not know what the world will look like in January when 'normal' business picks up again. Three-month bills fell to minus 0.01% on Tuesday, implying that funds are now paying the US government for protection.

"You know the US Treasury will give you your money back, but your bank might not be there," said Paul Ashworth, US economist for Capital Economics. The gold markets have also been in turmoil. Traders say it has become extremely hard to buy the physical metal in the form of bars or coins. The market has moved into "backwardation" for the first time, meaning that futures contracts are now priced more cheaply than actual bullion prices.

It appears that hedge funds in distress are being forced to cash in profits on gold futures to cover losses elsewhere or to meet redemptions by clients. But smaller retail investors— and perhaps some big players— are buying bullion in record volumes to store in vaults. The latest data from the World Gold Council shows that demand for coins, bars, and exchange traded funds (ETFs) doubled in the third quarter to 382 tonnes compared to a year earlier. This matches the entire set of gold auctions by the Bank of England between 1999 and 2002.

Peter Hambro, head Peter Hambro Gold, said the data reflects a "remarkable" shift in the structure of the market. The rush to safety reflects a mix of fears about the fragility of world finance and concerns that the move towards zero interest rates could set off an inflationary surge further down the road, and possibly call into question the worth of some paper currencies. The near paralysis in the "repo" markets may prove to be no more than pre-Christmas jitters as banks square their books.

However, there are some signs that extreme monetary stimulus by the US Federal Reserve and other banks is starting to have unintended consequences. The Bank of Japan says it is reluctant to cut its rates to zero again because of the damage this causes to the money markets, which serve as a key lubricant of the credit system. The US is now starting to face the same dilemma.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

40-Year Cycle

The 40-Year Cycle Is Still On Track
(Gold And Gold Stocks Within The 40-Year Cycle)

By Olaf Sztaba, Na-Marketletter | 11 December 2008

The extreme oversold condition of the markets should give way to a short but strong double-digit recovery rally that fits well into our 40-year cycle model (Meisels Cycle). Where do we stand? How did Gold and Gold stocks perform during the previous secular bear markets and financial crises? Let's look at the long-term picture and some strategies for the coming years.

The 40-Year Cycle

In past years, we have advocated the presence of a 40-year cycle. This cycle, also called the Meisels Cycle, is a combination of the widely followed 4-year or Dunbar cycle, and the 10-year or Decennial cycle formulated by Mr. Juglar.

The 40-year cycle suggests that the market repeats itself with a 40-year periodicy. To know what is likely to happen, we should look at the previous 40-year cycles. What we are experiencing now is some kind of repetition of the 1960-1970s and of the 1920-1930s.

What happened to Gold and Gold stocks in these two periods of high financial distress?

1929-1935

During the 1920s, the dramatic growth in investment trusts fuelled a rise in the stock market, which accelerated toward the end of the decade and quickly reached mania proportions. The buying frenzy in financial assets, as represented by the Dow Jones Industrial Average (DJIA), reached its zenith at 385 in October 1929. During the next three years, the Dow Jones Industrial Average lost 89% of its value to reach a low of 41 in June 1932.

In the initial reaction to the crash, Gold stocks had a strong decline during which Homestake Mining fell from $11.50 to $7.00 and Canadian producer Dome Mines tumbled from $5.50 to $3.00. It didn't last long. Shortly after, large investors began shifting their funds from plunging financial instruments (soft assets) to Gold stocks (hard assets). As a result, from the crash low in 1929, Homestake Mining advanced from $7.00 to a final peak in January 1936 just above $68.00, an 871% appreciation. Over the same period, Canadian producer Dome Mines advanced almost 1000%.

1974-1981

From the mid-1960s, the US market succumbed to another investment mania. The all-together-now attitude, accompanied by a highly popular use of leverage for speculation, pushed equities toward inevitable collapse. In the late 60s, the US stock market began its descent into a cyclical bear market.

As in the early 1930s, Gold stocks staged a huge comeback as investors started to shift funds from soft assets (mostly technology stocks) to hard assets (Gold stocks). Gold stocks, led by Domes Mines, Campbell Resources and Homestake Mines, to name just a few, roared to life, providing significant gains during a period of severe financial distress. The bull market in Gold and Gold stocks culminated in 1981 with Gold reaching a high of $850.

2000-2014?

Referring to the 40-year cycle, if we take history as a guide for the coming months and years, September 2000 was the end of a multi-year bull stock market phase that started in 1982-1983. The sell-off into 2002 violated the long-term up trendline on the S&P 500 index. The index then rallied into marginal [[but only nominal: normxxx]] highs in 2007 to create what some would call a 'double top'. The tone was then set for the start of a secular downtrend.

According to our 40-year cycle, we believe that we are pretty close to a medium-term cycle low that should set the stage for the next recovery rally into mid-2009. From late 2009 onward, our research indicates new lows into late 2010 or early 2011, another recovery rally within the secular downtrend into 2012, and another sell-off into 2014, which could then be the start of a new base-building process and set the tone for the next major bull market.

If history is any guide, the areas of the market that should do well during the next five years are Gold and Gold stocks (hard assets), just as in the 1929-1935 and 1974-1981 periods.

What to do?

For long-term investors:

Long-term investors should take the rise into mid-2009 as an opportunity to reduce their positions in equities and put their money into safe assets. They could offset any capital losses with previous long-term capital gains. Others may consider hedging their portfolios with put options or ETFs. The main goal should be to preserve the capital base for the next major bull move [[— as much as 10 years out: normxxx]].

At the same time, investors should watch for early signs of improving technicals in Gold and Gold stocks. The focus should remain on big-cap Gold stocks such as Barrick Gold, Goldcorp or Agnico-Eagle. Only a decisive move above the 200-day moving average would warrant a longer-term investment opportunity in these stocks.

For traders or medium-term investors:

Those with the ability to time transactions could try to participate in both the rallies and the sell-offs. There are now plenty of financial instruments to do so. We suggest, however, tight stop losses at all times. Watch Gold and Gold stocks for any signs of detachment from the general market in anticipation of a major bull market in these stocks similar to the 1929-1935 and 1974-1981 advances. We shall publish updates on the 40-year cycle along the way and strive to provide you with actionable investments and trading ideas, both in the short-term and the long-term to help you get through these challenging times. Stay tuned!

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Obama: In For A Nasty Surprise

Obama White House Is In For A Nasty Surprise

By John Crudele, NYPost | 11 December 2008

So, the president-elect thinks the economy will get worse before it gets better!?! As refreshing as his candor is, Barack Obama really doesn't understand what he's up against. Put your ear real close to this column. There are some dirty little secrets I'm going to tell you that I don't think anyone in the Obama Administration should hear.

Here goes: unless the incoming president quickly gets his act together we are going to be hearing the word "depression" a lot next year and he will— in a very short period of time— be as unpopular as the guy leaving the job. Why is this a secret? Because the folks in Washington just don't seem to deal well with reality.

And their ideas? Phew, they just don't live in the real world! Don't get me wrong. I'm certainly not wishing this on us. And I don't even think I'm telling you anything you don't already know. But they don't know it.

Last week Federal Reserve Chairman Ben Bernanke, a scholar of the 1930s Big-D, scoffed when a reporter asked him during a news conference if we're headed for horrible economic times. The Fed head pointed out that the unemployment rate reached 25 percent during the Great Depression and the job market only revived because we had to spend a lot of money to fight the Germans. Here's what the Obama White House should— but won't want to— know.

Right now, the unemployment rate would be more than twice as bad if you go back to the way this figure used to be calculated. In 1994 the Clinton White House decided that the unemployment rate calculation needed to be "modernized". So anyone who had been out of work for at least a year was no longer counted as unemployed— they were obviously just too lazy and/or 'discouraged' to find work. Those clever Clintons also changed the way the questions were asked, so that even more people would drop out of the unemployment statistics.

John Williams, an economist who tracks this stuff on his Web site ShadowStats.com, says today's unemployment rate would be 16.5 percent if we went back to the old way of measuring it [[and even more, if we counted the new legions of the 'self-employed' and the 'invisible' (undocumented) workers: normxxx]]. As it stands, the government announced last Friday that the jobless number climbed 0.2 percentage points to 6.7 percent in November, when an astounding 533,000 positions were eliminated. And the Labor Department also corrected the previous two months— now admitting that nearly 200,000 additional jobs disappeared right before the election.

The broader unemployment number that the Department does produce— called the U-6— rose to 12.5 percent in November from the previous month's 11.8 percent. This figure includes people who want to work full time but can only find part-time gigs. There's a certain irony in the fact that Obama, the first Democrat to win the White House in eight years, is going to be deceived by employment numbers that were first fudged by the last person in his party.

Here are a few things Obama should know and maybe contemplate for a while. The new president thinks rebuilding the nation's infra-structure is the kind of stimulus the economy needs to start cranking again. But will any of the workers fired last week by, say publisher Houghton Mifflin, DuPont, Viacom, AT&T, Avis and dozens of other white-collar heavy companies, really want to pour cement, dig ditches and engage in the brutal tasks that repairing roads and bridges will create?

When Roosevelt created jobs with infrastructure stimulus in the '30s, America was a blue-collar society that employed mostly men— at best semi-skilled. We, 'highly educated', white-collar prima donnas, aren't going to benefit from this program, no matter how many billions the government spends. [[They wound up paving over Japan and building lots of roads to 'nowhere', including an airport that no one uses and a 'floating' city, to no avail; Japan remains mired in deflation after almost three decades. But, having had one experience with hyperinflation, they opted NOT to hyperinflate the currency.: normxxx]] But a lot of illegal workers willing to work hard should do quite well. We'll be getting thank yous soon from the Mexican government, which could benefit more from this than NAFTA.

And The American Job Situation Is Worse Than Anyone Can Imagine

Last Friday's disastrous labor numbers included 30,000 jobs that the government 'thinks' were 'created' by companies too small to count. This is called the 'Birth/Death' calculation. But don't count on these positions really existing[[— the reverse is probably true, since this model notoriously overshoots at the turns in employment: normxxx]]. This is a Labor Department trick: Count these imaginary numbers in the current month and then subtract them later when the shock won't be so great. January is the only month when this birth/death model deducts jobs from the monthly count. So the job figure coming out Feb. 6— just weeks into the new administration— could be mind bogglingly bad.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

The Case For A Rally

Getting Technical: Building The Case For A Rally

By Michael Kahn, Barron's | 3 December 2008

While still a risky proposition, the case for a short-term market upswing is starting to build. It just may be a decent holiday season for the stock market despite the ongoing problems facing the economy. Even though it was just two days ago that the Dow Jones Industrial Average suffered a decline of 680 points, it's fourth-largest point decline in history, it's clear that a number of positives are building.

My favorite analogy is that a market forecaster operates very much like a trial lawyer in court. Aside from any theatrics either may employ, both seek to build a case piece-by-piece until the evidence points towards a conclusion. For investors, that conclusion is buy, sell or hold.

To be sure, we've had several exciting, but quick, "short covering" rallies over the past two months. Bears who held short positions decided to take their profits. It incites a stampede of buying. But without a true change in the supply and demand picture, it cannot and does not last for long.

However, over the past two weeks, we have seen three occasions where buying was more than simple covering of short positions. While volume was not impressive, the trading activity that did occur had an element of broad-based intensity that is not seen very often. And since the market was rather washed out already, these instances of surging buying interest suggest that there is a segment of market participants that are just itching to get back in. I interpret that as demand.

Critics will point out that such interest in the market means that it has not suffered its final capitulation where the last stalwart bulls finally give up, but that is an incorrect assessment. We have seen quite a few days of such "get me out of stocks" selling behavior, most notably the several days of disgorgement leading into the October 10 low and again at the October 27 low. This pair of conditions— the washing out of the market and renewed interest— is a positive for the market and we should put it on the bullish side of the ledger. It is not enough to declare it time to buy but, again, we are still crafting the case to do so and are not quite done.

Another positive comes from simple chart reading and momentum analysis. Last week, I pointed out that the major market indexes had formed patterns called "falling wedges," a bit of jargon for a declining trend that has lost its downside power (See Getting Technical, A Thanksgiving Deferred?, November 26). This week, the indexes are threatening to break out to the upside from their respective wedge patterns. For example, the Standard & Poor's 500 tested the top border of its pattern last Friday and despite Monday's monster decline it is once again knocking on the door to that breakout (see Chart 1).

Chart 1

One of the observations I have made over a 22-year career looking at charts is that strong markets tend to hover near resistance features— the upper border of the wedge, in this case. Weak markets tend to fall away from resistance quickly after touching it. The latter was the case on Election Day, and the index fell hard after touching the upper border of the still-forming pattern.

Momentum readings, such as the MACD (moving average convergence divergence) shown in the chart, have also been climbing from low levels even though prices had been setting lower lows. This divergence between the two tells us that the urgency to sell has abated— another sign of a shift from bear to bull. Again, neither of these conditions, the firmness of the index within the wedge pattern and the momentum divergence, is a green light to buy, but let's add both to the bullish side of the ledger.

Ian Woodward, market guru at High Growth Stock Investor software, said, "There is no silver bullet," referring to each indicator chart watchers use. "But two lead bullets are better than none and four are better than two," he added. That means that the more different types of indicators we can add to the bullish side, the more likely the market will reward us with a rally.

We can add continued gloomy sentiment of investors and a somewhat calmer volatility index (VIX) to the above to create a decent case for a short-term rally. It's still a risky argument but it is the best one I've seen in many, many months.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Dow 5,000 Redux

Dow 5,000 Redux
Click here for a link to complete article:
By John Mauldin, Outside The Box | 9 December 2008

What is fair value for stocks? Are they now cheap? You can certainly make that argument by comparing valuations based on past performance. But repeat after me, "Past performance is not indicative of future returns." The investment climate of today is almost certainly going to be quite different than that of the 80's and 90's. Thus, to expect stocks to repeat the performance of the last bull market in a climate of government intervention, deleveraging and increased regulations may not be realistic? [[We probably will have to wait a few years— 14, to be exact!: normxxx]]

This week Bill Gross, the Managing Director of PIMCO (and one of my favorite analysts) moves away from his familiar neighborhood of bonds and offers a few thoughts on stock market valuations. This is not a lengthy read, but it is one you might want to read twice, as the concepts are important. And not just for stocks but for investments of all types. I trust you will enjoy this week's Outside the Box.

John Mauldin, Editor

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Outside The Box: Dow 5,000 Redux

By William H. Gross | 9 December 2008
Managing Director, PIMCO

Here I go again! Gosh it was only six years ago that I cemented my place in stock market history by predicting that the Dow would fall from 8,500 to 5,000, instead of going up to 14,000 where it peaked in October of 2007. Well, I could use the standard set of excuses: 1) No one else saw it coming, 2) I was misinterpreted, and taken out of context, 3) I was tired, overworked, and had family problems, or 4) I had just come out of rehab.

But these days what really works is a full confession. I mean, like, uh, it was totally my fault and I take full responsibility. The fact is I was only off by 9,000 points. That's my story, and I'm stickin' to it.

Well, fools rush in. This time though I'm definitely older and maybe a little bit wiser. No magic number, nor a specific target date from the Swami of the Dow. This one will be more 'conceptual', but still present a "take" that you can criticize or damn with faint praise. And no, despite the title, it doesn't imply that the stock market is headed to 5,000 and that I was always right or just a little bit early. It only suggests that I'm readdressing the critical topic of equity valuation— that mysterious fragile flower where price is part perception, part valuation, and part hope or lack thereof. Press on, Swami.

Let me first announce a fundamental premise with which I think all rational investors would agree: I believe in stocks for the long run— but only if purchased at the right price. That statement packs a real punch. It says that capitalism is and will remain a going concern, that risk-taking— over the long run— will be rewarded, but only from a starting price that correctly anticipates the economy's growth and its share of after-tax corporate profits within it. Acknowledging the above, let's look at a few basic standards of valuation that historically have stood the test of time, to see if at least the price is right.

One of them is what is known as the "Q" ratio, or the value of the stock market relative to the replacement cost of net assets. The basic logic behind "Q" is that capitalism works. If the "Q" is above 1.0, then the market is valuing a company at more than it costs to reproduce it; stock prices should fall. If it is below 1.0, then stocks are undervalued because new businesses can't be created at as cheap a price as they can be bought in the open market.

In the short run, this ratio is volatile, as shown below, but it tends to be mean reverting, which is critical. As long as capitalism is a going concern, "Q" should mean revert to 1.0. If so, then oh, oh, oh what a "Q"! Today's Q ratio has almost never been lower— certainly not since WWII— implying extreme undervaluation, as seen in Chart 1.

Another long-term standard of valuation comes from the good ol‘ P/E ratio, where earnings per share, or E, is compared as a function of P, or price. Chart 2, going all the way back to 1871, shows the same relatively massive undervaluation, not only in the U.S. but elsewhere. This has been a global bear market. Yet here one should be careful.

The sage of rationality, Yale's Robert Shiller, cautions us to look at earnings on an historical 10-year moving average to remove adverse or fortuitous cyclicality. When measured on this basis, P/E's are cheap but less so, [only] slightly below their mean average for the past century.

Professor Shiller may be on to something, although even his 10-year approach may not be enough to adjust for our future economy. [That is, how it is likely to] function within the context of a delevering as opposed to a levering financial system. Recent Investment Outlooks and, indeed, discussions in PIMCO's Investment Committee and Secular Forums for the past several years have pointed to the necessity to view current changes as not only non-cyclical, but non-secular. They are, in fact, likely to be transgenerational.

We will not go back to what we have known and gotten used to. It's like comparing Newton and Einstein: both were 'right' but their rules governed entirely different domains. We are now morphing towards a world where the government fist is being substituted for the invisible hand, where regulation trumps Wild West capitalism, and where corporate profits are no longer a function of leverage, cheap financing and the rather mindless ability to make a deal with other people's money. Welcome to a new universe, stock market investors!

In this rather "sheepish" as opposed to "brave" new world, here are some considerations that may affect Q ratios, P/E's, and ultimately stock prices for years to come:

1. Corporate profits have been positively affected for at least the past several decades by several trends that appear to be reversing. Leverage and gearing ratios— the ability of companies to make money by making paper— are coming down, not going up. In addition, the availability of cheap financing— absent the government's checkbook— will likely not return. Narrow yield spreads and low real corporate interest rates are gone. Last, but not least, the historical declines of corporate tax rates, shown graphically in Chart 3, will not likely continue downward in a Democratically-dominated Washington.

2. Globalization's salutary growth rate of recent years may now be stunted. While public pronouncements from almost all major economies affirm the necessity for increased trade and policy coordination, and avoiding the destructive tendencies of one-off currency devaluations as a local remedy for global problems, investors should not bank on the 'free trade' mentality of recent years to support historic growth rates. Already we are seeing separate ad hoc policy responses with very little cooperation. Not only does the EU's approach differ from that of the U.S., but France is in many ways an odd man out within its own community. [[Haven't they always been!?!: normxxx]] Asia is legitimately suspicious of any U.S. endorsed approach given the failure of America's capitalistic model. [[And China is already devaluing independently of anyone else.: normxxx]]

3. 'Animal spirits', and with them the entrepreneurial dynamism of risk-taking has likely experienced a body blow. Not only have dancers on the financed-based dance floor been shown the exit à la Chuck Prince, but those that remain have been publicly chastened and handcuffed. Golden parachutes, options, executive compensation and bonuses themselves are now at risk. Care to climb to the throne of this new world? Well, yes, egos will always dominate, but the rules will be changed and hormone levels lowered.

4. The benevolent fist of government is imperative and inevitable, but it will come at a cost. The champion of free enterprise, Ronald Reagan, knew that growth of the private sector was in no small way dependent on deregulation and the lowering of tax rates. Now that those trends have necessarily come to an end, no rational investors should expect innovation and productivity to be unaffected. Profit and earnings per share growth will suffer.

My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to— that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner.

Dow 5,000? We don't have to go there if current domestic and global policies are focused on asset price support and eventual recapitalization of lending institutions. But 14,000 is a stretch as well. One only has to recognize that roughly 20% of bank capital is now owned by the U.S. government and that a near proportionate share of profits will flow in that direction as well. Better to own corporate bonds than corporate stocks, but that's a story for another Investment Outlook.

William H. Gross
Managing Director

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

The "Golden Age" Of G.W. Bush

The "Golden Age" Of G.W. Bush
Unretired: Retirees Are Back, Looking For Work
They Saved. They Planned. Then Housing Tanked And The Markets Melted. Now They Need Jobs, And There Aren't Any

By Heather Green | 7 December 2008

Six years ago, Paul Nelson gave up his long career in the defense industry for what he thought would be a peaceful retirement in Tucson. The weather was mild, the neighbors friendly. He had plenty of time to volunteer and garden.

But retirement hasn't worked out the way he planned. In 2006 his wife of 46 years died unexpectedly. He tried to swap their house for a smaller one and lost a chunk of his retirement savings in the process. Then this year the stock market cratered, wiping out almost everything he had left.

Now the 71-year-old is looking for work at local hardware stores and Home Depot (HD) and contemplating filing for personal bankruptcy. "I have nothing left," says Nelson, a former Raytheon (RTN) engineer. "I am not alone, I think." Far from it. An increasing number of people who retired in recent years, confident they had set aside enough to live on comfortably, are finding themselves strapped.

The stock market plunge and the housing downturn have affected many Americans, of course. But retirees have been particularly pinched because their homes and investments are the primary assets they depend on for income. As a result, many of the country's elderly are finding themselves in Nelson's situation, low on money and looking for work. "Suddenly the rug has been pulled out from under them," says Alicia H. Munnell, director of the Center for Retirement Research at Boston College.

Angry And Betrayed

These are The Unretired. Seniors who thought they were set for life just a year ago now face the prospect of going back to work for two, five, even 10 years. They're sprucing up their résumés, calling old work contacts, and flocking to employment sites. There are no reliable stats yet on how many retirees are looking for work, but there are clear signs the number is growing.

RetirementJobs.com, the largest career site for people over 50, saw traffic more than double, from 250,000 visitors in July to 600,000 in November. In April, before the worst of the market downturn, a survey conducted by the seniors group AARP found that 17% of responding retirees over 50 were considering or already going back to work. These aren't just the spendthrifts or sloppy planners you would expect to run into trouble in retirement. Interviews with 35 of The Unretired show that many are people who did everything they were supposed to do— working for decades and regularly socking money away.

Floyd McCoy, 67, retired three years ago after working for IBM (IBM) for 22 years and running his own consulting firm. But his $400,000 in savings has dropped 40% this year, and the value of his Weston (Conn.) house is down by a third. McCoy says he can't afford to keep the house he and his wife built 25 years ago for retirement. "I never knew life could be as challenging as this," he says.

The problems are compounded by a weak economy, with companies shedding jobs rather than hiring. Many retirees have been looking for months without luck. Their search is complicated by what some feel is a general reluctance to hire seniors, who may need extra training or extra health care. Gordon Scott, who lives in Solomons, Md., retired last year after 39 years as a police officer and teacher.

With his savings down 30%, Scott started looking for a job and attended orientation for nursing school. "I was disappointed with my reception," says the 61-year-old. "You're viewed differently. I can pick up the signs."

Peter Fay, like many of The Unretired, feels angry and betrayed. The 63-year-old built up a $1 million retirement account as an executive at companies including Chiquita Brands International (CQB) and then at his own high-end flooring company in Scottsdale, Ariz. But with all his money in stocks, he's lost 50% of that this year, at the same time that his house has tumbled in value.

He's drawing down his savings and applying for jobs at Lowe's (LOW), Home Depot, and Costco (COST). "All the systems we grew up trusting during all those years of work— you save your money, you trust in the government— are no longer valid," he says. Retirees have been squeezed during past economic downturns, of course. Their stocks tend to get hit, and returns on fixed-income holdings slide as interest rates are cut to stimulate the economy.

But there hasn't been this kind of sharp decline in stocks and home prices at the same time since the Great Depression. In addition, more retirees have exposure to the stock market than in the past because companies have moved from traditional pension funds to employee-managed retirement accounts, such as 401(k)s, which tend to include stocks. A Vanguard survey of clients aged 55 to 64 at the end of 2007 found that two-thirds of their retirement funds were in stocks.

"A lot of people invest by themselves, and they aren't aware of all the risks," says Benjamin H. Harris, senior research associate at the Brookings Institution. Congress held hearings on the issue of retiree security in October. Some politicians say the government needs to get involved soon. "We can't allow the promise of a secure retirement to become another casualty of the financial crisis," says U.S. Representative George Miller (D-Calif.), chairman of the House Education & Labor Committee.

Paul Nelson certainly thought he'd had the kind of long, stable career that would lead to a comfortable retirement. As an engineer at Raytheon, Honeywell International (HON), and Hughes Electronics, he helped develop the manufacturing processes used to put together circuit boards and aircraft products. "I am, like a lot of engineers, detail-oriented," Nelson says.

That thoroughness led to managerial roles and plum assignments. He and his wife moved often, living in Minnesota, California, and Colorado before settling in Claremont, Calif. They lived at the foothills of the San Gabriel Mountains for 20 years and raised a daughter there. When Nelson had an opportunity to retire early at 61 after Raytheon purchased Hughes in 1997, he jumped at the chance.

He took his pension as a five-year payout and went to work for Eurostep, a consulting firm involved in a project he'd begun at Hughes. Five years later, at 66, he retired for good with about $500,000 in his retirement accounts. He and his wife started looking for a place that wasn't as expensive or smoggy as Los Angeles.

They settled on Tucson in 2004, partly because Nelson was an avid stamp collector, and the Southwestern city was home to the nonprofit Postal History Foundation. For 30 years Nelson had collected stamps as a hobby and published newsletters about them. The couple used the money from the sale of their house in California to help buy a five-bedroom, one-story home in an established Tucson neighborhood with a country club. Nelson didn't spend his time on the golf links, though.

He joined the board of directors of the Postal History Foundation, working on one of its programs that uses stamps to teach children about history, government, and the world. He also spent time visiting his daughter and grandchildren in Minneapolis, gardening, and getting to know people in his community. "I don't know how I found time to work," jokes Nelson.

In July 2006 his wife was diagnosed with leukemia. "She wasn't feeling well for a month or so, but didn't want to go to the physician," says Nelson. "Then she felt bad enough that we went to the emergency room, and that was the end." Eight days after the diagnosis, his wife died. The following March he put the house on the market and bought a three-bedroom place.

He only put down 10%, even though that meant a higher mortgage, because he expected to sell his other house quickly and put down more. But the local real estate market suddenly started cracking. "The market waited for Nelson to make a stupid move," he says. Three months later, he cut the price on the house he was selling. Other cuts followed as the market spiraled down.

"We didn't get any offers that year. People were cautious," says Nelson. "We would get lookie-loos, and then the market would drop again, and we would lower the price." As the problem dragged into the summer, Nelson decided to put his second house on the market, too. To cover both mortgages, he dipped into his savings.

He started looking for a job, signing up for online employment services, including Monster.com (MNST). He got no responses beyond interviews with placement services. Then Wall Street began its slide last fall, and the savings in his retirement accounts started draining at an alarming speed. Nelson stopped eating out and canceled his newspaper, magazine, and cable subscriptions.

"I cut back on everything I know to cut back on," Nelson says. He applied to retail stores but found they weren't hiring because of the downturn. Finally, this spring, one family offered to pay the current asking price on the bigger house. It was about $400,000 less than Nelson had listed it for originally, but he jumped at it. He took his second house off the market briefly, thinking he could refinance it. "But by then, I didn't have anything to use as credit," he says.

Over the summer, Nelson realized the precarious situation he was in. He met with a bankruptcy lawyer in June, though he hasn't decided whether he'll file for protection from creditors. "I am paying the bills, but not the mortgage," he says. His real estate agent is negotiating with the bank to sell the second house to a prospective buyer for $80,000 less than the mortgage, he says. If his bank agrees, Nelson plans to move into an apartment and find a storage unit for some family furniture that's precious to him.

These days, Nelson says he is living off his monthly Social Security check of $1,700 and has no savings left. Nelson talked to his daughter and son-in-law about moving near them in Minneapolis. But he worries that things are tough for them too, since they're both self-employed. "I am clearly torn," he says. Since his daughter also has three kids and doesn't have an extra room, he has to rent an apartment, whether it's in Minnesota or Arizona. "I am pretty tense," he says. "It's going to be a struggle."

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Insight: A Rocky Road To 2010

Insight: A Rocky Road To 2010

By Aline Van Duyn, Ft.com | 3 December 2008

A look at banks’ marketing slogans— no doubt chosen with great care and sincerity not so long ago— is extremely uncomfortable. "Where vision gets built," was how now-bankrupt Lehman Brothers defined itself. "When your money is safe everything is too," Dexia proclaimed, before receiving a $9bn capital infusion from various European governments in September. "Live richly," said Citibank, in the not-so-distant days when it wanted people to borrow money even if they did not need it. Such exhortations now have an extremely hollow ring to them.

And the much-needed return of confidence to the financial markets together with the amelioration of the collapse of many parts of the banking system remains elusive. The hits to the real economy— in the US, Europe and even China— are severe and continue to get worse. There are no signs that lending will do anything other than shrink in the coming months, putting a further squeeze on both companies and consumers.

The sheer scale of what has happened to financial markets is taking a psychological toll and affecting how investors and others approach the markets. Here’s just one small example of the frenzy: Mary Miller, head of Fixed Income at T Rowe Price, a fund management group with more than $340bn of assets, told me that organisers of the company’s annual conference looking to the year ahead want her slides two weeks in advance. That has never been a problem before, but this year she felt her comments would not stand up for that long. In the end, she submitted them one day in advance.

Ms Miller, who has been covering financial markets for decades and stresses that she has seen plenty of downturns, talks of the "fatigue and disbelief" experienced by investors such as herself. This is shared by many of the bankers and policymakers I speak to. One of the biggest strains has come from trying to absorb the "never ending patchwork of solutions" devised by governments. Anyone tracking the many market intervention plans by the Fed and the Treasury knows the list is dizzyingly long, and that details are still in many cases sketchy [[at best! : normxxx]].

The many moves to inject liquidity into financial markets are clearly going to last longer than had been thought a few weeks ago. Just this week, the Fed added another three months of life to three liquidity facilities. These will now run until at least the end of next April.

Jeffrey Rosenberg, head of credit strategy at Bank of America, says this is an acknowledgement that the "period of adjustment" in financial markets will take longer than initially anticipated. Understanding how government’s new role has changed markets and investment opportunities is key. Bill Gross of Pimco highlighted that change this week.

"We are now morphing towards a world where the government fist is being substituted for the invisible hand, where regulation trumps Wild West capitalism and where corporate profits are no longer a function of leverage, cheap financing and the rather mindless ability to make a deal with OPM— Other People’s Money," he wrote in his monthly investment outlook. His advice to stock investors is to embrace the "sheepish" rather than "brave" new world and get used to lower earnings, growth and reduced "animal spirits". In such a cautious environment, risk-taking remains largely absent and often unwise.

Indeed, Ms Miller says the focus for investors is to just get through to the end of the year, and then hope for some stability in 2009. One bank slogan has proved to be prescient. "Here today, where tomorrow?" was how Fortis, the embattled Belgian-French insurance giant and financial services firm, marketed itself, complete with question mark. This could well be a slogan for current sentiment throughout the financial markets.

A few months ago, 2009 was predicted to be a turnround year. Now many investors are hoping for stability at best [[a reduced VIX?: normxxx]], as the question of "where tomorrow?" remains so hard to answer. Real improvements and growth? Maybe in 2010, but that is the view of the optimists.

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Fed Extends Its Emergency Lending

By Ft.com | 3 December 2008

Ben Bernanke, the Fed chairman, said the economy remained under "considerable stress" and made clear that policymakers would use unconventional central banking tools to support it, such as buying long-term government bonds, in addition to the more 'normal' short term interest rate cuts.[[Not so normal with ST rates already at a 'nominal' 1% and 'effective' rates close to zero.: normxxx]]

The 'lending facilities' provide loans to bond dealers, lend to banks buying asset-backed commercial paper from mutual funds, and auction loans of Treasury securities. They will now last a further three months until the end of April. The extension brings these facilities into line with other central bank initiatives to combat the credit crisis, the Fed said.

However, the announcement only added to growing fears about the US economy, which has already been in recession for nearly a year, according to the National Bureau of Economic Research, the leading independent economic authority. The NBER— which defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months"— said on Monday that a 73-month economic expansion that started in November 2001 had ended in December 2007.

Moreover, the 'lending facilities' have not [[had the effect of : normxxx]]reducing the benchmark floating rate, three-month dollar Libor, used for floating rate mortgages and loans, in line with the Fed's current target rate of 1 per cent. Three-month Libor remains highly elevated at 2.2 per cent.

The question for many economists now is how long and severe the recession will be. A growing body of gloomy economic data and indicators, including the increasing strains felt by manufacturing companies, is raising fears that the downturn in the US— and globally— is getting worse. Still, there is "no comparison in terms of severity" between the current downturn and the Great Depression, according to Mr Bernanke.

Others are more doubtful. "If this is a normal recession, demand should be about to turn higher, if it has not done so already unbeknown to most observers," said Stephen Lewis, chief economist at Monument Securities. He added: "First, if the US economy is [just] entering a depression, it is far too soon, even for an equity market that tries to discount conditions six months or a year ahead, to be looking for economic recovery. Second, the very fact that, at a point in the cycle when the downswing in a normal recession would be bottoming out, the economy seems to be plunging [instead], suggests this is not a normal recession. It looks more like the kind of slump that leads into a depression."

Ed Yardeni, president of Yardeni Research, said: "The average post-war recession lasted 10 months, So maybe this one is almost over." But given the latest raft of figures, he and his chief economist are forecasting the recession will not end until June 2009, which means it could last 18 months. "If it continues into the second half of next year, we'll all agree that it's a depression," he said.

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U.S. May Be In For ‘Great Recession,’ Longest Postwar

By Steve Matthews and Timothy R. Homan | 2 December 2008

Dec. 2 (Bloomberg)— The U.S. economy, now officially in recession, may be in the midst of the longest slump in the post— World War II era as job losses mount and credit dries up. The jobs report has been negative every month since January and the decline has been accelerating. The last time the U.S. was in a recession was from March through November 2001, according to NBER.

"We’re looking at some pretty severe numbers for the fourth quarter, and the first quarter of 2009 will be pretty bad as well," said Stephen Stanley, chief U.S. economist at RBS Greenwich Capital in Greenwich, Connecticut. "The economy isn’t going to turn around definitively until the credit markets unclog." Norbert Ore, chairman of the Institute for Supply Management’s factory survey, said, "This may be referred to as a 'Great Recession', because of its length'. It looked like we were headed for a shallow recession earlier in the year because of higher energy prices. With the meltdown in the financial sector, it has become something more serious".

But, the NBER designation means the U.S. was likely the first country to have slipped into a contraction. While definitions differ, the economies of both the euro area and Japan probably fell into a slump in the second quarter of this year, making it the first simultaneous recession in the three regions in the postwar era. The longest economic slumps since 1945 were the 16-month downturns that ended in March 1975 and November 1982. The Great Depression lasted 43 months, from August 1929 to March 1933.

Manufacturing Slump

American manufacturing contracted in November at the steepest rate in 26 years, the ISM said yesterday. The Tempe, Arizona-based group’s report came as factory indexes in China, the U.K., euro area, and Russia all fell to record lows. Federal Reserve Chairman Ben S. Bernanke, a former member of the NBER panel, said yesterday the economy "will probably remain weak for a time" and the Fed may use unconventional methods, such as buying Treasury securities, to spur growth.

"We have gone through in the last year a remarkable set of events, ranging from housing market to credit market to financial market shocks," James Poterba, president of the NBER and an economics professor at the Massachusetts Institute of Technology, said in an interview. "The collection of shocks is a very rare coincidence. It is not terribly surprising you might get a longer-than-average downturn."

Job Losses

The loss of [more than 2.7 million jobs since December] was the biggest factor in determining the starting point of the U.S. recession, the NBER said. By that measure, the contraction substantially deepened last month. Payroll employment fell by [533,000] in November, the most [of any month since 1974], according to the Labor Department report of Dec. 5. The jobless rate [increased to 6.7 percent], the highest level since 1993.

[ Normxxx Here:  November's drop in payroll employment (the 11th consecutive decline) followed declines of 403,000 in September and 320,000 in October, as revised (BLS). Job losses were large and widespread across the major industry sectors in November.  ]

"[This recession] is clearly not going to end in a few months," Jeffrey Frankel, a member of the NBER committee and a professor at Harvard University, said in an interview. "We would be lucky to get done with it in the middle of next year." Of all 11 NBER-called recessions since 1947, only two others involved no two consecutive quarters of negative real growth before the call. The one in 2001 and the recession of April 1960 to February 1961. However, that latter recession involved one quarter with significant negative growth, -5.1% annualized, and a cumulative -1.0% growth for a whole year.

[[Sounds like the NBER is adjusting for our flaky inflation figures!: normxxx]]

Second Bush Slump

The contraction is the second under President George W. Bush‘s watch, making him the first U.S. leader since Richard Nixon to preside over two recessions. Lawrence Summers, President-elect Barack Obama’s pick for White House economic adviser, said the economy is getting worse and requires more legislative action. "Recent economic evidence suggests that the pace of this downturn is accelerating," Summers said in a statement. He said Obama wants to enact a recovery package "soon after taking office".

Although a recession is popularly defined as two quarters of successive contraction in real gross domestic product, the private committee doesn’t require supporting GDP data to make a recession call. Its members focus on month-to-month changes in the economy as a whole. The NBER committee defines a recession as a "significant" decrease in activity over a sustained period of time.

The decline would be visible in gross domestic product, payrolls, industrial production, sales and incomes. The U.S. economy shrank at a 0.5 percent pace in the third quarter after expanding 2.8 percent in the previous three months. Economists at Goldman Sachs Group Inc. and Morgan Stanley in New York are among those projecting the economy will contract at a 5 percent pace this quarter.

"The recession is likely to last at least into the summer of 2009," said Conrad DeQuadros, a founding partner at RDQ Economics in New York. "Even as the economy begins to recover, it’s likely to still feel like a recession, and the unemployment rate is still likely to rise."

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Recession Is 'Official:' Is It Time To Look Forward?
Click here for a link to complete article:

By Kent Thune, TheFinancialPhilosopher | 1 December 2008

"It' easy to see— hard to foresee." ~ Benjamin Franklin

Now that we are "officially" in a Recession, what does that mean for stocks going forward?

Of course, no one really knows the answer to that question, and I certainly will not attempt to answer it here. What some of you may not know, however, is that, once the "recession call" is made, stocks have historically been quite close to a significant march upward. The reason for this is that, traditionally, economists look backward and investors look forward.

The stock market is often referred to as a "discounting mechanism." Discounting, in reference to stocks, is essentially a means of pricing the value of stocks today based upon their expected value in the future, typically six to nine months in time— a "crystal ball," if you will, reflecting forward expectations of economic health. In other words, much like a barometer that measures the general business and consumer confidence of our economy, stock prices today [is supposed to] reflect our nation's general economic health six months from now. For this reason, the stock market, as measured by the S&P 500, is a component of the economic Index of Leading Indicators.

"You cannot see the mountain near." ~ Ralph Waldo Emerson

Now for some perspective: From the high mark on October 9, 2007, to the recent low mark put in on November 20, 2008, the price of the S&P 500 declined 51.93%. Of course, we will not attempt to "call a bottom" or make any predictions here. But a few observations are in order with specific reference to data (and following table) taken from Fidelity's Market Analysis, Research & Education (MARE):

Here are the prime points, in reference to the table above, from the November 26, 2008, MARE article, "US Stocks Often Rebound During Recessions:"

• The average U.S. economic recession— defined as a period of significant decline in economic activity— has lasted about 11 months.


• Investors historically have begun anticipating a recovery in the economy and in corporate earnings prior to the end of a recession.


• On average, the stock market has begun to recover about halfway through a recession, with the typical rebound being about 25% in magnitude (from market low point to end of recession).


• Bear markets that have occurred during past recessions also have tended to end during those recessions (73% of the time, 8 out of 11 instances).

"Faced with the choice between changing one's mind and proving there is no need to do so, almost everyone gets busy on the proof." ~ John Kenneth Galbraith

While it is true, as Keynes said, that "the market can remain irrational far longer than you or I can remain solvent," it is also true that 'irrational' investors eventually grow tired of their exhausting behavior; the excesses of the market are diminished or removed [[including its volatility: normxxx]]; and the pendulum finally begins to swing in the opposite direction— the direction of the 'rational' investor...

ߧ

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A Leading Bear Turns Bullish, Sort Of

A Leading Bear Turns Bullish, Sort Of
Click here for a link to complete article:

By Robin Goldwyn Blumenthal, Barron's | 7 December 2008

An interview with Barry Ritholtz, CEO and Director of Equity Research, FusionIQ: Getting ready for a "significant" rally.

For the past five years, Barry Ritholtz has been entertaining, educating and elucidating readers of his blog, The Big Picture. Among the noteworthy calls that the savvy lawyer and sometime-trader has made: identifying a credit bubble a few years ago, and a recommendation to short AIG back in February, when the share price was flirting with $80; it's now about $1.80.

Lately, the 47-year-old Ritholtz, with his business partner, Kevin Lane, has had a chance to put some of those ideas to work at FusionIQ, a firm that manages nearly $100 million in separate accounts. Amid the wholesale destruction on Wall Street, Fusion has produced single-digit gains on its long-short portfolios, and has kept the average losses on its long-only accounts to single digits. Ritholtz, whose book Bailout Nation is due early next year from McGraw-Hill, can be trusted to call 'em as he sees 'em. To find out what the contrarian is now warming up to, read on.

Barron's: What's your global outlook?

Ritholtz: In 2006, I was probably the most bearish guy on the Street; now at a table of industry people, I'm the bullish guy. We've cut this market in half; that doesn't mean it can't go lower. We're in a medium recession. If this turns into a deeper, more prolonged recession, all bets are off.

Are we are testing a real low here?

There's no doubt we're looking at an extremely oversold market. But by the end of the week, that oversold condition could be worked off. There's upside here for a trade. Over the past 100 years, we've only seen the relative strength of the S&P 500 drop to this level five times, and each time, it has been a major buying opportunity, although not necessarily a major bottom. If you look at 1929, it was a low but it wasn't the low, and there was a bounce. It was the same thing after Sept. 11— from Sept. 21, you had a 40% bounce in the Nasdaq before you went down to make all-time lows.

Will the market drift?

It's flapping up and down. There is a significant rally, 20% or 30%, waiting to happen. But there's also the possibility of a lower low, as we get deeper into the recession, if things take a terrible turn for the worse. Whenever you're fragile, you don't have the ability to absorb that next blow. My fear is that some economic issue arises and you don't have the resiliency to deal with it.

We're economically stretched very, very thin. Things seem to be getting healthier at an ungodly cost, one which we will be dealing with the unintended consequences of for decades. We're really at the fork in the road. Everybody on Wall Street is wondering if we're going to see a year-end rally of any substance, or, if we're heading down to 7100 on the Dow, or 850 on the Nasdaq. [On Friday, those indexes were at about 8200 and about 1430, respectively.]

What say you?

We're waiting for a couple more things to line up: Some clarity on earnings, which we won't have for a while, some sort of resolution on these bailouts, and some sign from the new administration that, unlike the outgoing group, we have a plan— "Here's what we're going to do about credit, banks, the economy, GM." We wouldn't be surprised to see earnings seriously damaged.

Wall Street is still way too high. They started out the year at earnings of $103 a share on the S&P 500 for 2008, which got them to 1600 on the index. We came in at $65 a share, and that may have been too bullish. The good news is that most of corporate America outside of the financial sector has healthy balance sheets, lots of cash, and is running very lean.

Except for the auto industry.

The auto industry is a whole other story. The auto industry is a story of terrible management, misguided unions, and government intervention.

What's your impression of the bank bailout?

[Treasury Secretary] Hank Paulson is really the imperfect messenger for this bailout. Remember that Paulson is one of the five executives who went to the SEC in 2004 to beg, 'Please, let us lever up more. Please let us go to [a leverage ratio of] 30 or 40.' It is bad enough that he helped create the crisis. It appears that this whole response is completely ad hoc.

Do you see any guiding principle?

It is, how do you give money to banks who need capital and not say, 'By the way, you're cutting your dividend.' What's happening instead is they're saying, 'Here is money: Give it out as dividends and bonuses.' It is unbelievable. There is no clawback. It is unconscionable.

So, what does it take to invest in this kind of world? How do you stay out of trouble?

We have a number of internal rules. The most important is that we always have a stop-loss. When the trade is working out, we use trailing stop-loss, meaning that the higher the stock goes, the higher the stop-loss. When the market starts heading south, we get taken out. We screen for short squeezes, and we've found that they're very often present at the beginning of a major move up.

We back-tested [price/earnings ratios] and found they have no forecasting ability. Whenever people do an analysis of a stock, the tendency is to create a snapshot at a given moment. We try to build a moving picture of a stock. For instance, if you know you're in an all-time peak in home sales, and the Fed is in a tightening regime, why own a stock in a homebuilder?

The builders have been pretty beaten down, though.

I've been the biggest bear on housing on the Street for four years now. Housing is halfway through. We're not even close to the bottom in housing. The stocks were always cheap, so it's not a valuation question.

Given the uncertainty in the market at large, what appeals to you right now?

We've been trading the two-to-one leveraged [exchange-traded funds]. One is the Ultra S&P ProShares [ticker: SSO]— for every dollar the Standard & Poor's 500 moves, it moves two dollars. And there's also Ultra Triple Q ProShares [QLD], the Nasdaq 100-version of the SSO. The flip of the QLDs are the QIDs, which are the negative two-for-ones on the Nasdaq. We're starting to look at that.

We are now running about 70% cash, which is inordinately high. Some of the names we're watching, and have owned in the past, are NuVasive [NUVA], a medical-device company, Stanley Works [SWK], a great infrastructure story, LG Display [LPL] and Luminex [LMNX]. Industries we like are infrastructure, defense, biotech and medical devices.

Why ETFs?

We're normally bottom-up stockpickers. But when we're looking at all these individual stocks and war-game them, we end up saying there's this risk and that risk. Here's an example: JPMorgan [JPM] is probably the best house in a bad neighborhood. It had a nice run, then it pulled back; do we want to own JP Morgan? What's the risk?

They've already acquired Bear Stearns. They have to be looking at Goldman Sachs [GS]. They have to be looking at putting the house of Morgan back together. If that happens, what happens to the stock price of JPMorgan? You could lose 15%, 20% overnight. Every time we look at individual stocks, we end up with that analysis.

We spent a lot of the year running a good chunk of cash. Some of that is discipline; a lot of that is staying away from things that are really trouble. The trade that caused so much trouble for people— long financials— we're at the point where some of the financials are starting to look attractive.

Would you give us a name?

Citigroup [C] at $5. The interesting thing about Citigroup is that if there's anything that's legitimately too big to fail, Citigroup is it. If you think the consumer and retail sector are having a hard time, imagine if Citigroup were allowed to go belly-up. People would hunker down in their homes and stop buying all but the necessities.

I didn't really buy that Bear Stearns was too big to fail, although there was the argument that they could take JPMorgan down. Citibank is one of those things that cannot be allowed to go belly-up. It's enormous. It's the equivalent of AIG.

What else do you like?

We like infrastructure, plays like Stanley Works, and we expect there will be some stimulus to build ports, bridges, and expand the electrical grid. Defense is another sector we like, though it's less so of the Boeing s [BA] and more of the specialty-defense names, like AeroVironment [AVAV], which makes small, pilotless drones. There's a list of interesting biotech and medical-devices companies, which are insulated from the economic cycle. We just bought Cubist Pharmaceuticals [CBST], which addresses the anti-infective market.

In the same way the Internet bubble gave rise to Web 2.0, Facebook and blogs, the Genentechs of the world and all the developments that took place throughout the 1990s have led to the current new wave of specialized therapeutics. Over the next 10 years, we're going to see a universe of breakthroughs based on the previous 20 years' work. The first order of business on Jan. 20 [presidential-inauguration day] is allowing stem-cell research, and that's going to lead to a number of significant breakthroughs. Medical devices and gene therapies are ripe areas. The problem is, they're very volatile and very speculative, and not necessarily safe for the ordinary household.

What stocks are you shorting?

We've been short Jefferies & Co. [JEF] for a while. They're similar to the various asset gatherers: In this environment, it becomes very challenging to hold on to key people. The best guess is, they're suffering along with the rest of the sector, only they don't have the strength or the size to do things that a Goldman Sachs or a Morgan Stanley or Wachovia can.

Table: Ritholtz's Picks

What about gold?

Gold is really quite interesting here, as are the gold miners. We own no gold now, and we own no gold mines, but we are watching them. The question is, at what point does this deflationary cycle roll over to the point where things start to get better? We were among the loudest inflation hawks for the past few years. When oil was $147 a barrel the joke was, which was going to hit $6 a gallon first, premium gasoline or skim milk?

In March, we said we are through the worst part of the inflation cycle and now we should see deflation as the economy starts to roll over. And that is pretty much playing out. The bugaboo with all that is you just had the Fed triple its balance sheet. The Bernanke printing presses are running full speed. That ultimately has to hurt the U.S. dollar; it ultimately has to be inflationary.

Has gold bottomed?

I don't know where gold bottoms. We recommended gold for the first time in 2002 or 2003. It was strictly an inflation trade, thanks to Greenspan. And then when the GLD gold ETF first came out, we recommended that. Gold has a date with $1,500 somewhere in the future [up from $763 an ounce now], but whether it makes that move from 700 or from 400, I have no idea. You just can't print that much paper and debase the currency and not see some sort of reaction.

Anything else look interesting?

We always tell people when things are really good you have to make emergency plans. You know, the time to read that card on the seatback in front of you is not when the plane is heading down. When things are really awful like they are now, that's when you start making your wish list. I have never owned Berkshire Hathaway [BRK], but if it was cheap enough I'd buy it.

A level, please?

$85,000 to $95,000 [versus $98,000 recently].

Where else might you be deploying some of that cash?

One client said to me, "I'm tired of hearing bad news. I don't care what it is, what can you tell me that is good?" I told him to make a list of things he's wanted to own, but has been afraid to buy or unable to because of the cost.

I don't care if it is art, trophy properties, vacation homes, collectible automobiles or boats. Figure out what you are willing to pay, and I can all but guarantee you that by the time we are done with this deflationary cycle, many of those objects will be available at your price. I wouldn't be surprised if, when everything is said and done, a lot of these things are off by 50% or worse.

Thanks, Barry.


  M O R E. . .


Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Good News-- Conditions Resemble 1973-74!

Being Street Smart: Good News— Conditions Resemble 1973-74!
Click here for a link to complete article:

By Sy Harding | 5 December 2008

The recession of 1974-75 was the worst since the 1930’s Great Depression. The 1973-74 bear market in anticipation of that recession was the worst bear market since that of the 1929-32 bear market (which led to the Great Depression). The mid-1970’s were indeed a miserable period. So how can it be good news that the prospects for the current recession, and the current bear market, resemble those of that period?

Because there are an increasing number of pundits predicting this economy is headed down into a second Great Depression, and that the current bear market will need to be as severe as that of 1929-32 (a decline of 90% in the Dow) in order to factor in that disaster. But that is highly unlikely, and I’ll tell you why. In my 1999 book Riding the Bear— How to Prosper in the Coming Bear Market, I did compare the 1999 market bubble, particularly in the Nasdaq, to the 1929 market bubble, and predicted the subsequent bear market (which turned out to be the 2000-2002 bear) would be the worst since that of 1929-32.

I made that comparison that time because the market of the 1990s had been so similar to that of the 1920s. Both had been preceded by a record bull market lasting almost 10 years, during which, without periodic corrections to relieve them, the excesses of stock overvaluations and investor euphoria had gotten wildly out of control. In both eras the thought that it was ‘a new era’, in which bear markets were a thing of the past, was inspired by a historical technological breakthrough that made such thinking seem reasonable. In the 1920s it was the introduction of electricity into homes and factories. That made for significant increases in factory and office productivity, resulting in thousands of new products being introduced, and exciting new start-up companies to produce them.

In the 1990s it had been the introduction of powerful and inexpensive computers, automation products, and the Internet. That also made for significant increases in factory and office productivity, resulting in thousands of new products and services being introduced, and exciting new start-up companies to produce them. So in both eras the thought followed that the growth of new products and companies would continue unabated, and the prices of their stocks would just keep climbing for decades.

However, in each era the stock bubbles broke. In the 1929-32 bear market the Dow lost 90% of its value. In the 2000-2002 bear the Nasdaq lost 78% of its value.

The current bear market cannot be compared to either. Stock prices were certainly not in a bubble at the bull market top last October. It was the economy that was headed for trouble, the result of the bursting of the housing bubble, and the stock market rolled over into the current bear market in anticipation of a recession. So the current bear market can more accurately be compared to previous bear markets that took place in anticipation of recessions, not to the two bear-markets that were related to stock market bubbles.

I believe it can be compared particularly to the period of 1973-75, when the worst recession since the 1930’s Great Depression took place. At that time there was also a world-wide shortage of oil. There was a war in the middle east (the Yom Kippur War between Israel and Egypt/Syria).

There was the Arab oil embargo, which quadrupled the price of oil and gasoline to record levels, causing despair among consumers and businesses, not only due to the quadrupled prices, but because vehicles had to wait in long lines at gas stations for limited rations of gas. The spiked up price of oil, combined with other problems, sank the economy into its worst recession since the Great Depression.

A previously popular president (Nixon) had fallen sharply out of favor, and was pre-occupied with his own problems (Watergate scandal), not much interested in the economy, and made a number of blunders, including instituting wage and price controls. Consumer and investor confidence reached extreme lows. The media was full of gloom and doom. The consensus expectation was that the economy was definitely on its way into a second Great Depression.

It wasn't a credit crunch that made it extremely difficult for businesses and consumers to pay their bills or get mortgages, resulting in spiraling foreclosures and bankruptcies. It was inflation, which spiraled wildly out of control, reaching 14% a year, interest and mortgage rates soaring to 15%. It became an ugly period of 'stagflation', when jobs were being lost in large numbers yet prices of everything were soaring, significantly affecting the ability of consumers to meet living expenses.

Meanwhile, until 1979, when Paul Volcker was named Chairman of the Federal Reserve, no policy makers were making any effort to halt the out-of-control inflation spiral. However, by then, 1979, the stock market, always looking ahead, had already ended the 1973-74 bear market, surging up 73% from its November low in 1974 to its high in 1976. That the current bear market may be factoring in a recession as severe as that of the mid 1970’s is not necessarily a reason for investors to despair now. (The time for that was at the year-ago top).

In factoring in the 1974-75 recession, the Dow declined 45.1% in the 1973-74 bear market, the worst bear market since the 1929-32 crash, and the next bull market began when fear and despair were at their most extreme. The Dow was recently down 46.6% at its November low, the S&P 500 down 52.9%. And we’re all aware of the level of fear and despair. Time to buy?

Sy Harding publishes the financial website Street Smart Report Online, and a free morning blog. In 1999 he authored Riding The Bear— How To Prosper In the Coming Bear Market. His latest book is Beating the Market the Easy Way— Surprising Seasonal Strategies that Double the Market's Performance.

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Not There Yet!

All The Symptoms Of A Nearing Bottom— But Not There Yet!

From A Usually Reliable Source… | 4 December 2008

Last week I said, "News-driven rallies aren't what investors should be looking for; they should be looking for strong emerging sectors that are rallying from an improving fundamental outlook. Unfortunately, the fundamentals are not changing for the better in the financial world, and they're likely to get much worse." I also talked about the need for the major indices to be able to consistently hold up against bad news.

Last week we rebounded off the lows to put in an impressive 18% rally in the S&P 500. However, as the averages moved up, the volume was lighter each day than that of each preceding day. I realize that it was a holiday week and volume is always lower, but it appeared to me that this rally was just window-dressing by institutions at the end of the month. This same pattern also appeared across the board on many past leading stocks.

As expected, the media were very excited that we went up for five straight days, but as I look over the data from the weekend, there was absolutely no leadership to support the strength. This flaw certainly showed up on Monday of this week as the market sold sharply off, giving back 6% of last week's move by 1 p.m. After a five-day move, the market was obviously overbought and due for a pullback, but a sharp selloff like this is not a positive follow-up.

Let's look at a chart of the S&P 500.


Click Here, or on the image, to see a larger, undistorted image.

I have been telling readers that in order to turn the intermediate-term trend higher, the S&P must get above the 900 level, consolidate and then successfully break above the November high of 1000. When you see low-volume moves on a wedging technical pattern into resistance, it is just a prescription for failure. That leaves me telling the same old boring story: Stay in cash!

Nevertheless, from a longer range technical, sentiment and institutional money flow standpoint, there do appear to be some important changes occurring in the market. I started pointing them out as early as Oct. 10 when I said:

"Depending on how the market closes today [Oct. 10], I may start to look for some long-side opportunities in the indices I have highlighted. The key will be for a big down opening this morning, and then we close higher at the end of the day. ... If that happens, it may be a good time to start small positions in these areas with protective sell stops directly beneath those lows."

That situation happened that very day, and I began to take positions in the index ETFs. What I especially liked was we had a whoosh down in the morning that took out the previous lows and triggered a massive number of sell stops. On the week ending Oct. 10, when the S&P 500 hit an intraday low of 839, the number of stocks hitting new lows on the New York Stock Exchange (NYSE) reached an unprecedented 2801.

I later noted that the sentiment indicators were hitting historic extremes.

We have had sentiment readings such as consumer confidence, which was so severe it fell from 65.2 (1985=100) in March to an all-time low of 38.8 in October (but has since improved moderately to 44.9 in November). The worst decline ever in both speed and magnitude. The Present Situation Index decreased to 42.2 from 43.5 October. The Expectations Index increased to 46.7 from 35.7. Retail has also hit a wall— along with industrial productivity, which is suffering its worst decline since 1974.

Technically the stock market has produced all of the symptoms of trying to form a significant bottom since October 10, and has reasonably succeeded except for that 'poke' below about two weeks ago (November 20-21)— but the number of stocks on the NYSE at fresh 52-week lows dwindled considerably on that move. At this point, the S&P 500 is seemingly making an attempt at an inverse Head & Shoulders (on a slighly downwards slanting base) with the left shoulder around 850, the head around 750 and the right shoulder around 810-15.

If the market is trying to form a significant bottom, the next question is what kind of bottom? Is it to be a major bottom that holds for a number of years [[not likely: normxxx]], an intermediate-term bottom that holds for months to a year [[most likely: normxxx]], or a short-term bottom that holds for just a few weeks [[it's already lasted longer than that: normxxx]]. The first step is to determine whether a bottom has actually been reached.

As the market has managed to defy all the usual rules over the past few months, I am not ruling anything out, but simply looking at my indicators and historical precedents (such as they are). Nevertheless, the situation is looking brighter than it has for some time. I'm sure readers are still asking how I can be more optimistic when the news is so terrible. In fact, the economic news continues to be the worst since at least the 1980-1982 downturn, worst than most expectations, even the more pessimistic ones.

But, if you have been studying the market for any length of time, you know that markets tend to bottom when economic conditions are at their absolute worst, and it's hard to imagine them getting much worse than they are right now. With the government and the Federal Reserve seemingly ready and willing to take whatever measures are necessary to flood the economy with money and support to avoid a major depression (something over $8.5 TRillion is in the pipeline of which $3.2 TRillion has already poured out into the economy), the current situation should continue to improve. The credit markets are beginning, ever so slightly, to loosen(?) and we have support from the oil markets with oil trading below $50 a barrel. That last is not something that is likely to hold for the long term, but it sure helps our current situation.

Part of the nature of the stock market is that it is predictably unpredictable. It stands ready and willing to fool the majority of investors at every opportunity. In the past, I said that my indicators and other research pointed to the 'possibility' of a short-term bottom, and that I was dipping my toe back in the water with a small percentage of index proxy longs. But the problem with the current market environment is that there is no leadership in stocks or sectors, and that is what you need before you can even think that the intermediate— and long-term trends have changed [[ie, for the better: normxxx]].

Still, there has been evidence that some kind of bottom is developing. The major averages have been bouncing around in a pretty wide range, but not much progress has been made and the percentage of shares at new lows has continued to shrink. This tells me that the recent decline is nearing at least a short-term exhaustion phase.

The current bear market, with the S&P 500 having been down 52% at its November low, has already been the worst bear market of the last 77 years. And, just about very time in the last 110 years that the market has declined more than about 35% (and often much less), not only a rally, but a new bull market, has begun.

One bear market of the last 110 years might have been different, and it was by far the worst one ever, that of 1929-32. And in it we see that although the bear market had two more years to go before reaching its final bottom, after its initial decline of 40.6%, it experienced a bear market rally that lasted for five months, (from November 11, 1929 until the following April 25), and which amounted to a 34% rally. Only then did it drop another 87.5% with hardly a pause to its final bottom in July, 1932.

So it can actually be said that the current bear market is the only one in which the market has declined by as much as 52%, and has not yet experienced either a sizable bear market rally, or the beginning of the next bull market. We cannot know what the future will bring in any area of life or business. All we can do is look at the data, the history, and the similarity of conditions, and then act on the odds that a specific set of antecedent circumstances will likely again precede a similar dénouement or outcome as in the past. In the final analysis, we can only play the odds of what worked well in the past— in every endeavor in life— otherwise, we couldn't even cross the street safely.

Again, make sure you have the confirmation of an upside breakout before you greatly increase your enthusiasm. And then, do so only slowly and tentatively— and try to concentrate on the supervalues, with assured sources of revenues and strong dividends, that are likely to wear well, such as XOM, not the rockets; it is quite likely that the market will see lower lows in 2009.

Remember to keep close protective stops on all positions in case today's selling accelerates.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Economies Continue To Unravel

World Stability Hangs By A Thread As Economies Continue To Unravel

By Ambrose Evans-Pritchard, Telegraph, UK | 1 December 2008

The political bubble is bursting. Spreads on geo-strategic risk are now widening as dramatically as the spreads on financial risk at the onset of the credit crunch.

Whether it is the Indian rupee, the Shanghai bourse, or Kremlin debt, the stars of the credit boom have fallen to earth. Investors are retreating into 3-month US Treasury bills— the ultimate safe-haven. The yield has fallen to 0.02%, less than zero after costs. You pay Washington to guard your money.

The working assumption of the "Great Boom" is— or was— that we live in a benign era where most societies are converging towards some form of market liberalism; where trade and capital flows are unrestricted; where governments have enough legitimacy to keep order by light touch; where a major war is unthinkable. This illusion is now being tested. We should not read too much into the Bombay carnage. It may or may not be significant that the Deccan Mujahideen— whoever they are— picked India's financial hub to launch their spectacular.

Even so, the love affair with Bombay's bourse was cooling anyway. The Sensex index is down almost 60% from its peak. The exodus of foreign capital may now quicken, laying bare the horrors of Indian public finance. The combined federal and state deficit is 8% of GDP. Plainly, spending will have to be slashed.

If the atrocity now propels the Hindu nationalist leader Narendra Modi into office at the head of a revived Bharatiya Janata Party (BJP), south Asia will once again face a nuclear showdown between India and Pakistan. Events are moving briskly in China too. Wudu was torched by rioters this month in a pitched battle with police. Violence has spread to the export hub of Guangdong as workers protest at the mass closure of toy, textile, and furniture factories.

"The global financial crisis has not bottomed yet. The impact is spreading globally and deepening," said Zhang Pin, head of the national development commission. "Excessive bankruptcies and business closures will cause massive unemployment and stir social unrest".

We are about to find out whether China has made the wrong bet with a development strategy of vast investment in manufacturing plant for mass export at thin margins to the US and Europe. The shocking detail in the World Bank's latest report on China is that wages have fallen from 52% to 40% of GDP since 1999. This is evidence of an economic model that is disastrously out of kilter, and unlikely to retain popular support.

The Communist Party lost its ideological mission long ago. The regime depends on perpetual boom to stay in power. As the economy sours, there must be a high risk that it will resort to the nationalist card instead. Tokyo certainly thinks so. When I visited Japan's Defence Ministry last year, the deputy minister showed me charts detailing the intrusion of China's fast-growing fleet of attack submarines into Japanese waters. "We see its warships in the Sea of Japan all the time," he said.

Shoichi Nakagawa, the head of the ruling LDP party, was even more explicit. "What happens when China attacks Japan? Will the US retaliate on our behalf?" he said. As for Europe, it is already fragile: Iceland, Hungary, Ukraine, Belarus, Latvia, and Serbia have turned to the IMF. Russia is a hostage to oil prices. If Urals oil stays below $50 a barrel for long, we are going to see an earthquake of one kind or another.

It is too early in this crisis to conclude whether Europe's monetary union is a source of stability, or is itself a doomsday machine. The rift between North and South is growing. The spreads on Greek, Irish, Italian, Austrian, and Belgian debt remain stubbornly high. The lack of a unified EU treasury has become glaringly clear. Germany has refused to underpin the system with a fiscal blitz.

In the 1930s, it was not obvious to people living through debt deflation that their world was coming apart. The crisis came in pulses, each followed by months of apparent normality— like today. The global system did not snap until September 1931. The trigger was a mutiny by Royal Navy ratings at Invergordon over pay cuts. Sailors on four battleships refused to put out to sea. They sang the Red Flag.

News that the British Empire could not uphold military discipline set off capital flight. Britain was forced off the gold standard within five days. A chunk of the world followed suit. Nor was it obvious that Germany would go mad. Bruning persisted with deflation, blind to the danger. The result was the election of July 1932 when two parties committed to the destruction of Weimar— the KPD Communists and the Nazis— won over half of the seats in Reichstag. [[And, foolishly, the government supposed that Hitler was the lesser of the two evils.: normxxx]]

We can hope that governments have acted fast enough this time— with rate cuts and a fiscal firewall— to head off such disasters. But then again, the debt excesses are far greater today. If in doubt, cleave to those countries with a deeply-rooted democracy, a strong sense of national solidarity, a tested rule of law— and [[nuclear weapons and: normxxx]] aircraft carriers. The US and Britain do not look so bad after all.

.

1930s Beggar-Thy-Neighbour Fears As China Devalues

By Ambrose Evans-Pritchard, International Business Editor | 3 December 2008

China has begun to devalue the yuan for the first time in over a decade, raising fears that it will set off a 1930s-style race to the bottom and tip the global economy into an even deeper slump. The central bank has shifted the central peg of its dollar band twice this week in a calculated move that suggests Beijing aims to offset the precipitous slide in Chinese manufacturing by trying to gain further export share abroad.

The futures markets are pricing in a 6% devaluation over the next year. "This is clearly a big shift in policy and we are now on alert," said Simon Derrick, currency chief at the Bank of New York Mellon. The move follows a Politburo speech by President Hu Jintao warning that China is "losing competitive edge in the world market". China has allowed a crawling 20% revaluation over the past three years. Any reversal risks setting off conflict with the incoming team of President-Elect Barack Obama in Washington.

Mr Obama has called China a "currency manipulator" during the campaign, a term that carries penalties under US trade law. Outgoing US Treasury Secretary Hank Paulson is viewed as a "friend of China". He called for a stronger yuan this week before embarking on a visit to Beijing, but the plea was couched in friendly terms. This soft-peddling may soon change.

Hans Redeker, currency head at BNP Paribas, said China's policy switch could set off a dangerous chain of events. "If they play this beggar-thy-neighbour game, it will cause a deflationary shock for the whole world," he said. It makes sense for countries with current account deficits such as the UK, US or Turkey to let their currencies fall, but China has the world's biggest trade surplus.

Michael Pettis, a professor at Beijing University, said it was "very worrying" that a pro-devalulation bloc seemed to be gaining the upper hand in the Communist Party. "I really do believe that we are on the brink of a very ugly period for trade relations," he said. China has relied on exports to North America and Europe as its growth engine, making it acutely vulnerable to the contraction in global demand.

Mr Pettis said this recalls the role played by the US in the 1920s, a parallel fraught with danger. "In the 1930s the US foolishly tried to dump capacity abroad, but the furious reaction of trading partners caused the strategy to misfire. China already seems to be in the process of engineering its own Smoot-Hawley," he said, referring to the infamous US Tariff Act of 1930.

China showed restraint during the Asian crisis in 1998, holding the line against domino devaluations across the region. It may yet hold the line this time. However, this crisis is more serious. The manufacturing sector has seen the steepest decline since records began, with devastation sweeping the textile, furniture and toy sectors. Civil unrest has begun to rock the Guangdong and Longnan regions.

Beijing has slashed rates and unveiled a fiscal stimulus of 14% of GDP, but most of the spending comes in the form of instructions to local governments to spend more— but without giving them the money. Does China really intend to step in to prop up global demand? The jury is out.

.

Is Britain Going Bankrupt?

By Ambrose Evans-Pritchard | 24 November 2008

The bond vigilantes are restive. We are not yet facing a replay of the 1970s 'Gilts Strike', but we are not that far off either. There is now a palpable fear that global investors may start to shun British debt as the budget deficit rockets to £118bn— 8 per cent of GDP— or charge a much higher price to cover default risk.

The cost of insuring against the bankruptcy of the British state has broken out— upwards— over the last month. Yes, credit default swaps (CDS) are dodgy instruments, but they are the best stress barometer that we have. Today they reached 86 basis points, near Portuguese debt in the league table. For good reason.

Alistair Darling has had to admit that the British economy faces the most sudden economic collapse since World War Two, and the worst budget deficit of any major country in the world. Ok, this is a lot lower than Iceland, Ukraine, Hungary, and other clients of the IMF, but is significantly higher than Germany (35 bpts), USA (43 bpts), and France (49 bpts). After trading at similar levels to our AAA-rated peers for years, we started to decouple in August and then began to soar in October.

We reached a fresh record the moment the Chancellor told the House of Commons that the budget would not return to its already awful condition until 2016. Should we be worried? Yes. Marc Ostwald from Insinger de Beaufort said Gilt issuance would reach £146bn in fiscal 2008/2009. Britain will have to borrow £450bn over the next five years.

This is an utter fiasco. With deep embarrasment, I plead guilty to supporting the Brown-Darling fiscal give-away— though with a clothes peg clamped on my nose. As the Confederation of British Industry and many others have warned, we face an epidemic of bankruptcies unless we tear up the rule book and take immediate counter-action.

The Bank of England's drastic rate cuts are a necessary but not sufficient stimulus. Monetary policy is failing to get traction because the credit system has broken down. We face the risk of a rapid downward spiral if we misjudge the threat at this dangerous moment, as we sit poised on the tipping point.

Besides, the whole world is now resorting to fiscal stimulus in unison under IMF prodding. Sticking together is imperative. If countries reflate in isolation, they can and will be singled out and punished. That is the lesson of 1931.

But this is not to excuse the Brown Government for the total hash it has made of the British economy. It presided over a rise in household debt to 165% of personal income. How could the regulators possibly think this was in the interests of British society? What economic doctrine justifies such stupidity? Why were 120% mortgages ever allowed? Indeed, why were 100% mortgages ever allowed? Debt is as dangerous as heroin.

Labour ran a budget deficit of 3% of GDP at the top of cycle. (We had a 2% surplus at the end of the Lawson bubble, so we go into this slump 5% of GDP worse off). The size of the state has ballooned from 37% to 46% of GDP in a decade, and will inevitably now rise further.

It is because Gordon Brown exhausted the national credit limit to pay for his silly boom that today's fiscal stimulus— just 1% of GDP (China is doing 14%)— is enough to rattle the bond markets. Our national debt will jump in what is more or less the bat of an eyelid from under 40% of GDP to nearer 60%— according to Fitch Ratings. It is enough to make you weep. But is this bankruptcy territory? Not yet. Britain will remain at the mid to lower end of the AAA club.

A Fitch study today estimates the "fiscal cost" of the bank bail-outs (which is not the same as just adding guarantees to the national debt) is 6.9% of GDP for Britain— compared to Belgium (5.7%), Germany (5.8%), Netherlands (6.3%), and Switzerand (12.9%). We are not alone in this debacle.

If and when the storm blows over, Britain should still have a lower national debt than Germany, France, or Italy. It will certainly have a better demographic structure that most of Europe (except France and Scandinavia), and less catastrophic pension liabilities than most. The situation is desperate, but not serious— as the Habsburgs used to say. Fingers crossed.

.

Germany Facing Worst Slump Since 1949

By Ambrose Evans-Pritchard | 24 November 2008

Euro-zone industrial orders plunged 3.9% in September and Germany's IFO index of business expectations has fallen to the lowest level since the survey began half a century ago, heightening fears of a severe slump across Europe next year.

French president Nicolas Sarkozy met Germany's Chancellor Angela Merkel in Paris yesterday to plead for stronger German support for an EU-wide rescue package. The talks come as the European Commission adds the final touches to a €130bn (£110bn) fiscal stimulus plan. Germany has clung steadfastly to budget orthodoxy but the downturn has now begun to engulf Europe's biggest economy with shocking speed. The Bundesbank is now expecting the worst recession since the terrible year of 1949, according to Deutsche Press Agentur.

Howard Archer, Europe economist at Global Insight, said the blizzard of dire data from the eurozone now points to a severe manufacturing slump. "Output, total orders, exports orders all contracted at record rates in November, which was alarming," he said. The broad IFO index of German confidence fell to the lowest since 1993 in November, but it was the unprecedented slide in the expectations index that most worried economists.

"This is extremely bad, it's even worse than the dog days of early 1970s," said Julian Callow, Europe economist at Barclays Capital. "German exports to the US, UK, Spain, and Italy have all collapsed, and the next shoe yet to drop is Eastern Europe," he said. Latvia has joined the queue waiting for an IMF bail-out, while Russia devalued the rouble again yesterday.

"The European Central Bank needs to cut rates very aggressively. They're trying to take this steady line, but this is a not the time for that. We think rates will be cut to 1.5% by February," he said. The ECB, which raised rates in a widely-criticized move in July, has since cut by just 100 basis points to 3.25%, largely staying aloof as the Anglo-Saxon central banks take drastic action to stop the downward spiral.

Adding to eurozone woes, the bloc's current account deficit doubled in September to €10.6bn despite the drop in the cost of imported oil. It is further evidence that the euro's surge to extreme levels of over-valuation in recent years has 'hollowed out' Europe's industrial base and inflicted damage that may take a long time to unfold.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Monetizing The Debt

Monetizing The Debt

By Axel Merk | 3 December 2008

Deflation won't happen here; at least not if Federal Reserve (Fed) Chairman's Ben Bernanke's plan pans out. Deflation is considered a persistent decline in prices of goods and services; in a speech in 2002, Bernanke outlined the steps he would take if the U.S. ever faced the threat of deflation. Deflation will suffocate anyone holding debt as the debt burden becomes more difficult to finance with shrinking income; in contrast, inflation bails out those who have a lot of debt. In our assessment, fighting deflation is the Fed's top priority now; the latest minutes from the Fed's Open Market Committee (FOMC) meeting state:

"Indeed, some [FOMC members] saw a risk that over time inflation could fall below levels consistent with the Federal Reserve's dual objectives of price stability and maximum employment. …the limited scope for reducing the [Federal Funds] target further were reasons for a more aggressive policy adjustment; …more aggressive easing should reduce the odds of a deflationary outcome…"

To understand how "more aggressive" easing is possible when interest rates are close to zero, a little background is required on how the Fed is "printing" money. Until a few weeks ago, the Fed's main tool to control interest rates was to manage the Federal Funds target rate by engaging in "open market operations"— to buy or sell short-term government securities, mostly Treasury Bills. These operations are based on the principle that banks have cash deposits as reserves to lend money.

For any dollar on deposit, a multiple number of dollars may be provided as loans; the basic principal of modern banking [being] that not all depositors will want their money back simultaneously. But, if they do, a 'run on the bank' that may occur in such a situation that would either result in the Fed coming to the rescue or the bank's failure. In addition, the Fed can "tighten"
monetary policy by selling, say, Treasury Bills in the open market.

[ Normxxx Here:  This last has the effect of lowering the price of all Treasury bills in the market (since they are now less scarce) and hence of raising interest rates (since the bills pay out a fixed dollar amount after issue). By making cash less available in the market place for these bonds, the cost of borrowing, i.e. interest rates, goes up. Conversely, the Fed can buy Treasury Bills, providing the market with increased cash, aka, 'liquidity'. By making bonds scarcer, their price goes up and, conversely, their yield goes down.  ]

This world was shaken when Congress, as part of passing the TARP bank bailout program, authorized the Fed to pay interest on [[on the reserve deposits of member banks': normxxx]] 'deposits' at the Federal Reserve. Theoretically, even if the Fed provides massive amounts of liquidity, interest rates should not go to zero as banks should always be able to go to the Fed and receive interest on deposits there. The idea is that the banking system could be flooded with liquidity while ensuring that [[short term: normxxx]] interest rates don't go down to zero.

Fed officials are fairly miffed that the market hasn't quite worked that way. Short term Treasury bills have hovered close to zero, even though the 'official' target Federal Funds rate is at 1%, and the interest paid on deposits at the Fed is at or near 1%. Note that many of the new programs the Fed has introduced have little or no historic precedent; as a result, the programs may not be effective or may have unintended consequences. [[They may even prove counterproductive!: normxxx]]

Aside from paying interest on deposits, the Fed, using the above model, can do a lot more to provide "liquidity". Namely, the Fed is not limited to buying and selling T-Bills, as recent announcements have shown. The Fed is free to buy just about anything: mortgage backed securities (MBS), car loans, commercial paper, to name a few. (The Fed could also buy typewriters, cars, domestic or international stocks— anything.) In an announcement on November 25, 2008, the Fed said it would buy up to $600 billion of mortgage-backed securities issued by the government-sponsored entities (GSEs) Fannie and Freddie.

For example, a bank would like some cash, but cannot find a buyer for the mortgage-backed securities it holds. The Fed may step in, buy the securities and provide the bank with the cash. The bank in turn is now free to lend the money— some multiple of the cash received.

How does the Fed get its money? It doesn't need to borrow it; it merely creates an entry into its balance sheet. All the Fed requires to "print" money is a keyboard connected to a computer. The difference between the Fed and the Treasury issuing money is that the Treasury needs to get permission from Congress before selling bonds. In this context, it shall be mentioned that physical cash (coins, bank notes) are entered as liabilities on the Fed's balance sheets; they are rather unique liabilities, however, as you can never redeem your cash: [[Treasury bills have not been redeemable since 1933: normxxx]]. While it is possible for central banks to remove cash in circulation, they are not obliged to do so.

Until recently, the Fed would only temporarily park non-government securities on its balance sheet, A bank would typically receive a temporary, often overnight, loan for depositing top rated securities with the Fed; these "swap agreements" were traditionally intended for very short-term loans, but the crisis has led the Fed and other central banks around the world to engage in 60, 90 day or even longer agreements. Since late September, swap agreements have been supplemented by outright purchases[[ of securities: normxxx]].

When the Fed issues [[new: normxxx]] cash [[ie, not borrowed from an existing holder of dollars: normxxx]] for the debt securities it acquires, we talk about "monetizing the debt". This can be taken yet a step further, although this last phase has not yet been implemented. When the government needs to raise money, the Treasury issues debt in form of Treasury bills and Treasury bonds.

To keep the cost of [[intermediate term and long term: normxxx]] borrowing for the government low, the Fed itself may step in and buy Treasury bonds. Whereas traditionally, the Fed actively manages short-term interest rates only, by buying and selling short-term Treasury bills, the Fed may also buy, say, 10- or 30-year bonds. It's a wonderful funding mechanism: if the Treasury needs to raise cash, the Fed could provide it as needed.

Isn't this extremely inflationary? Quite possibly, quite likely, but not necessarily is the short answer [[at least, not in the short run: normxxx]]. First of all, the Fed has the ability to "sterilize" its debt monetization program. Take the situation where the Federal Reserve buys "highly rated", 'toxic' assets from the bank, but doesn't want the bank to go out and lend a multiple of the cash it receives. What the Fed can do is to sell the same bank, for example, some Treasury bills to "mop up" the extra liquidity. This would have the impact of improving the bank's balance sheet without supercharging the economy.

Indeed, in late September the Treasury instructed the Fed to do just that. They even invented "Supplementary Financing Program" (SFP) bills for this purpose. On the chart below, the dark blue line indicates the cumulative growth in the Fed's balance sheet, i.e. the Fed's "printing of money"; the light blue line shows the cumulative activity to mop up the added liquidity by selling SFP bills to banks. The Fed's balance sheet has grown by about $1.2 trillion to currently over $2 trillion. Dallas Fed President Richard W. Fisher said the Fed's balance sheet may reach $3 trillion by January.

As even the untrained eye can see, the Fed has not mopped up all of its liquidity injections; indeed, as of October 22, 2008, the Fed seems to have all but abandoned the program. In our assessment, at least for the time being, the Fed is not interested in mopping up, but in adding massive amounts of liquidity.

Well, isn't that extremely inflationary? It depends on your definition of inflation; if it's a growth in money supply, then, yes, this is already extremely inflationary. But so far, this hasn't translated into higher price levels or even higher long-term inflation expectations as measured by the spread of 10 year TIPS versus 10 year Treasury bonds; TIPS are inflation protected Treasuries that provide compensation for increases in the consumer price index (CPI); it is this spread that the Fed is most concerned about when gauging the market's inflation expectations.

Why has it not (yet) been inflationary? Well, the Fed can provide all the money it wants, but it cannot force institutions to lend. Below is a chart of the "excess reserves" in the banking system; these are the reserves banks hold in excess of what they are required to maintain.(Fed statistical release H3, table 1 column 4):

Until September, excess reserves hovered at or below about US$2 billion, but have since ballooned to over $600 billion as of November 19, 2008. Read in conjunction with our discussion above on the Fed "printing money", the Fed has thrown money at the banking system, but the banks are hoarding the cash, they 'refusing' to lend [[often, not even to each other: normxxx]]. For banks to lend money, two basic conditions must be bet: they must themselves feel strong enough to provide the credit, and they must feel that their customers— be they consumers or businesses or even other banks— are sufficiently creditworthy.

Before we discuss the next step the Fed has taken in its [seemingly frantic effforts] to unlock credit [[ie, lending activity: normxxx]] in the economy, let's pause for a second to look at a potential unintended consequence. If you are a bank and don't want to lend to the private sector, but are awash in cash, what do you do? You can deposit the cash at the Fed and earn 1% interest; you can buy Treasury bills and earn approximately zero; or you can lend money to— the government. In our view, it seems a logical conclusion for banks to buy longer dated Treasury bonds.

Banks are [normally] in the business of borrowing short and lending long. Typically, banks have deposits (short-term loans from depositors or others such sources, eg, the 'commercial paper market', callable at any time) and [use that money] to lend to finance [other than Federal government] long-term projects. This may well be the greatest carry trade of all times, except that it has neither credit, nor currency risk; it does have interest risk, i.e. if long-term interest rates go up because the market prices in the risk of inflation, then the banks could lose money.

While Congress may be furious that banks are not lending, the Fed does have a conflicting interest in keeping the long-term cost of borrowing low. Under normal circumstances, the cost of borrowing should go up as unprecedented amounts of dollars need to be raised by the Federal government (eg, the Fed itself or the Treasury) to finance the various programs in the pipeline and for the additional spending programs expected by Congress. The cost of borrowing has the potential of going dramatically higher if Asian buyers [cannot] increase their [absorption of] U.S. debt. Asian buyers [[mostly Chinese: normxxx]] have, in recent years, purchased the majority of debt issued by the U.S.

Now, however, there's less trade with the U.S., and Asian governments need to stimulate their [own] domestic economies. While some may try to keep their exports cheap [[by keeping the value of their currency low with respect to the dollar, by purchasing U.S. debt: normxxx]], the Chinese approach of investing about US$600 billion [directly] into their domestic economy is more efficient. And unlike the U.S. government, the Chinese are sitting on over $2 trillion in foreign currency reserves [[about half of it in potentially toxic US dollars which they'd be only too happy to unload for something likely to prove more stable: normxxx]] and can afford to have a massive domestic stimulus package [[largely at the expense of the US dollar and US interest rates: normxxx]]. In our view, foreign governments are unlikely to be able to step in and keep U.S. borrowing costs low.

Never underestimate the Fed. If the money thrown at the banking system doesn't stick, i.e. doesn't result in easier credit for the rest of the economy, they can also be more targeted. As of November 25, 2008, the Fed has announced it will buy mortgage-backed securities in the open market to get the cost of borrowing down. Specifically, debt securities issued by Fannie and Freddie, the government sponsored entities, will be purchased.

Almost immediately after the announcement, the prices of these securities rose, causing the yields to go down. The goal of the Fed in this program is to keep the cost of borrowing for homebuyers low. While this will keep the cost of borrowing low for those who qualify for a loan, this program may do little to provide access to the mortgage market for those that have been shunned [by] it. This includes the difficulty for many of refinancing their home when its value is less than the value of the mortgage.

In our assessment, the Fed will do anything to keep the cost of borrowing low. This has included targeted purchases of mortgage-backed securities to help homeowners; this has included purchases of commercial paper to help corporate America; it has included providing banks with massive liquidity. And it may [eventually] include the outright purchase of government debt to help finance the spending programs in the pipeline.

What happens if the Fed keeps the cost of borrowing artificially low, either directly or indirectly? Traditionally, the Fed only controls the cost of short-term borrowing, but recent Fed actions set the stage for more active involvement throughout the yield curve, i.e. also for longer dated government bonds. Think about it from the vantage point of the potential buyer of Treasury bonds or Fannie and Freddie paper.

If the yield offered is artificially low, then potential buyers are likely to abstain. After all, there may be other investments whose price are less, or not at all, manipulated. Investors don't require a high, but a fair return on their money; they want to be compensated for the risk they are taking. This includes those who lend to governments.

In a world where the cost of borrowing is artificially lowered, it may be up to the Fed to be the backstop of all economic activity as other potential buyers become reluctant to act. [[In a deflationary world, stuffing excess cash into your mattress would do fine! : normxxx]]Paradoxically, it's precisely government debt that investors are looking for because of all the uncertainty in the private sector. However, as the U.S. does not live in a vacuum, international flows of funds do need to be considered.

A foreign investor may think twice before buying U.S. government bonds or agency paper, if they are not fairly compensated for the risk they are taking. Aside from our argument above that Asian buyers may not be able to finance U.S. spending, they may be put off by unattractive yields. After all, the massive stimulus under way should [eventually prove] highly inflationary.

But if the Fed succumbs to preventing the markets from pricing potential inflation into bond prices, there has to be a valve. This valve, in our view, will be the U.S. dollar. We cannot see the dollar hold up in face of the types of intervention that are under way and that we see play out. Incidentally, a substantially weaker dollar may be exactly what Fed Chairman Bernanke wants. He has repeatedly praised Roosevelt for going off the gold standard during the Great Depression to allow the [general] price levels to adjust to their pre-1929 levels [[ie, to combat deflation: normxxx]].

This is Fed-speak for praising the pursuit of inflationary policies. Bernanke's only criticism was that FDR didn't act fast enough. Similarly, Bernanke's criticism of the Japanese encounter with deflation has been that the Japanese have not acted forceful and fast enough to fight it. What he may [have overlooked] is that the Japanese have traditionally financed their deficits [and debt] domestically.

In the U.S., these days, most of the deficit [and debt] is financed abroad. The U.S. is lucky in that at least the debt is U.S. dollar denominated so that we can, at any time, repay the debt simply by printing more money. However, the value that foreigners may place on the U.S. dollar [[eg, in their own currency: normxxx]] may be substantially less, the more inflationary the policies that the U.S. is pursuing.

Many still believe in the infallibility of the Fed. Foremost, many support the massive liquidity push because they are firmly convinced that the Fed will mop up the excess liquidity when markets normalize. Indeed, without this confidence, the markets might [have already] overwhelmed the Fed and caused a disorderly outcome for inflation and/or the dollar.

Even we don't doubt that the Fed has the best of intentions. The Fed believes that the end justifies the means. However, we doubt the end will be as intended, thus doubly questioning the means. But just as the past 22 months have shown that the markets do not act exactly as Fed officials have anticipated, we cannot see that the Fed, Treasury and other government programs will work as designed.

While we don't rule out that an inflationary boom is possible, once the liquidity is starting to be mopped up, we are afraid, economic growth is likely to collapse once again. Unless real wages can be improved, consumers must de-leverage. Propping up a broken system will simply make the later crash even more severe.

[ Normxxx Here:  In other words, Axel forsees the same possibility of a general deflation interrupted by occasional bursts of runaway inflation, until we are all destitute, that I have written about earlier.  ]

Similarly, if Asian governments continue to support the dollar, they will seriously weaken their own economies. In a best-case scenario, we will then face the same challenges again in 10 to 15 years, but by then a country like China won't have $2 trillion in reserves, and have far greater difficulty in stabilizing its economy [[if it survives so long with an economy on the fritz: normxxx]]. The U.S. has taken the attitude that other countries must support the dollar because it is in their interest to do so. But there's a limit to what other countries can do; there's also a limit when it ceases to be in their own interests.

In particular, it is irresponsible for the U.S. to pursue a policy that is destructive to the dollar while counting on Asian governments to prop it up. In the meantime, responsible savers in the U.S. have their savings put at risk due to all the bailouts. A substantially weaker dollar may cause price levels to rise; as a result, the value of the dollar in international markets may be a better indicator of inflationary pressures to come than the yield curve that is distorted because of the various Fed programs. Fed Chairman Bernanke may want a weak dollar and inflation, but may ultimately be getting more than he is bargaining for.

We manage the Merk Hard and Asian Currency Funds, no-load mutual funds seeking to protect against a decline in the dollar by investing in baskets of hard and Asian currencies, respectively. To learn more about the Funds, or to subscribe to our free newsletter, please visit our site

The Grapes Of Wrath

The Grapes Of Wrath
Extracted From The Dec 2, 2008 Edition Of Richard's Remarks

By Richard Russell | 3 December 2008
Dow Theory Letters [big] snippet

The Bernanke-Paulson team is doing everything in its power to hold back the forces of deflation. The first indication that they're succeeding will be the stock market ceasing to deflate.

A trillion is the new billion. The government has thrown tens of billions [[trillions?: normxxx]] at the face of various deflating entities in a desperate attempt at halting deflation. It hasn't worked. The stock market's opinion, so far, is that "it's not going to work".

You can't cure the disease with more of the same "medicine" that caused the disease. The only cure for a crashing stock market is exhaustion, and it is probably the same for the US economy. The bear market in stocks has an economic equivalent— a severe recession, better known as a depression.

There is an inflection point somewhere ahead that will mark the death of deflation and the base for forthcoming inflation. We have not reached that inflection point yet. The stock market continues to deflate and the treasury bond market continues to discount deflation. If Bernanke and Paulson fail to halt deflation, we will be facing a deflationary disaster ahead.

It will wipe out all the leveraging and inflation built into the US economy since World War II. For years I've been writing that ultimately we will face the choice— "inflate or die." Depression and deflation are the economic equivalent of death. I saw it once, and I never want to see it again— which is what today's site is all about.

Maybe wealthy La Jolla isn't a fair test, but I walk around La Jolla, and life appears to go on as usual. No real changes except that I see more "Sale" signs on the retail shops, and I see more "For Lease" signs posted in the windows of various blacked-out store fronts. People are shopping, couples sit in the sun at outdoor restaurants chewing on hamburgers or sipping coffee. Nothing much has changed in dreamy La Jolla— it will.

What is changing is the stock market and the Treasury bond market. Treasury bonds are hitting new highs, as the conservative bond market crowd pours money into the Treasury market on the thesis that come what may, they'll always get their money back if they buy Treasuries (that is, unless the dollar tanks, I think to myself). Meanwhile, yesterday, the Dow was down over 679 points or 7.7%— so much for the five-day rally that served to get the bulls' hopes up.

My mind goes back to mid-1929. My parents are still giving cocktail parties for their friends (in those days, parties at restaurants were rare and unusual). My dad has just bought a Buick touring car, and we are preparing to take a ride to nearby Stamford, Connecticut. My sister and I are both going to private schools, and my mom is dreaming of getting out of the West Side and moving to the more "acceptable East Side".

Dad is looking over the stock tables in The New York Times, and he wonders why he has not been more adventurous— Dad will only buy two stocks, American Telephone with its famous $9 dividend and "recession-proof Woolworth," which he terms "the poor man's stock". During September through November of 1929, the market crashes. My uncle Irving jumps out of the tenth story window of a midtown Manhattan hotel. Irving commits suicide because his department store stock cuts its dividend in half (Irving lives on that dividend).

After the great crash of '29, nothing in Manhattan seems very different. I can still ride the subway to school, all the way to Riverdale for a nickel. And a good sandwich at the Automat still costs only 15 cents. I'm given 35 cents for lunch every day. I usually buy a sandwich or a plate of cheese macaroni for 15 cents and a piece of pie for a dime at the Automat.

One year later everything has changed. Men are out of work. The lines outside the employment offices are growing longer— some wind around the block. Tired men in patched clothes sit on the sidewalk with outstretched metal cups and signs that read, "Veteran, God bless you." The mood in the city is changing, and you can sense the fear in the air. My parents' friends are calling the house and discussing how much money they have lost in the stock market. Some have lost their jobs.

My father has a perpetual grim look on his face, he seems worried day and night. In the year 1939 my father loses his job. He suffers a nervous breakdown. My mom doesn't want me to see it, and they send me on a youth hostel bicycle trip to California. On that trip I see the "Grapes of Wrath" up close and personal.

California is filled with Okies and their beat-up trucks (people from Oklahoma who had fled the Dust Bowl and are looking for any kind of work in the Golden State). The California sheriffs and highway patrols are busy sending the poor Okies back home. "You want to work in California,bud? Forget it, we don't have enough jobs for our own." I'm stopped on my bike (I'm 16 years old) by the local sheriffs three times.

"Watcha doin' here kid? Lookin' for a job? Because if you are, I'm puttin' you on a box car and sending you back to wherever the hell you came from." "No sir, I'm with a Youth Hostel group. We're just sight-seeing." "Well you're not going to like the sights around here. And don't let me catch you lookin' for a job, kid. OK, get back on your bike— you can go."

Those were the fun days. I remember them well. And now I'm wondering whether we're headed for another round of such "fun days." The crashing stock market tells me it could happen. I don't want to see the days of 1939 ever again.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Will Historic Returns => Additional Gains?

Monday Morning Outlook: Will Historic Returns Give Way To Additional Gains?
Can The S&P 500 Index Extend Its Historic 5-Day, 12-Percent Rally?
Click here for a link to complete article:

By Todd Salamone, schaeffersresearch | 1 December 2008

Today's in-depth look at the week ahead begins with a recap of last week's historic 5-day gain for the Dow Jones Industrial Average, despite the Thursday Thanksgiving holiday. Next, Schaeffer's Senior Vice President of Research Todd Salamone looks at the potential for solid market returns following the S&P 500 Index's (SPX) impressive 12% rally. Joe Sunderman, Vice President of Financial Market Analytics, dives into the Nova/Ursa ratio, and why you should keep a close eye on this sentiment indicator. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: The Dow Jones Industrial Average Posts Best 5-Day Point Gain Ever
By Joseph Hargett, Senior Equities Analyst

Last week was one for the record books for the Dow Jones Industrial Average (DJIA). Despite the shortened-holiday week, the Dow gained 1,277 points, or 17%, in just 5 sessions, marking its best 5-day percentage gain since 1932, and its best 5-day point gain on record. The venerable average kicked last week off with a bang, rallying 396 points, or 4.93%, after word hit the Street that the U.S. government would bailout Citigroup (C), thus dodging another Lehman Brothers-style collapse.

Tuesday's gain amounted to just 36 points for the Dow, but it kept the streak alive despite a downwardly revised third-quarter gross domestic product and news that the Federal Reserve would buy up to $600 billion in mortgage-backed securities. Traders regained their footing on Wednesday, as the Dow jumped 247 points, or 2.91%, heading into the Thanksgiving day break. The rally wasn't easy, however, as traders fought their way past the sharpest drop in consumer spending since September 2001, the fastest contraction in durable-goods orders in 2 years, and a 25-year high in the 4-week moving average of initial jobless claims. Wall Street was "closed" on Thursday for the holiday, but traders returned with sated appetites on Friday.

Despite anxiety over a potentially weak showing for Black Friday, the Dow rallied 102 points, or 1.17%, bringing the average's gain to 9% for the week. Still, the impressive 5-day rally wasn't enough to save November, as the DJIA dropped 5% for the month. Elsewhere, the S&P 500 Index (SPX) added 12% for the week, but lost 7% for the month. Finally, the Nasdaq Composite (COMP) rose 11% last week, but shed 10% for November.

What the Trader Is Expecting in the Coming Week: Does an Historic Weekly Return Indicate Continued Market Strength?
By Todd Salamone, Senior Vice President of Research

The S&P 500 Index (SPX) rallied 12% last week, raising an interesting question: When did we last see the SPX exceed a weekly rally of 7%, and what happened during the subsequent months? I'll answer this question in a moment, but first, let's rewind to the week that preceded this historic 1-week return in the SPX.

Two weeks ago, we experienced a 6.7% decline in the SPX, but an impressive late-Friday surge broke the selling fever on Wall Street, as news hit that President-elect Barack Obama would name Timothy Geithner as his Treasury Secretary. As a result, the SPX rallied back above its 2002 lows at 768.63 and its October 2007 half high at 788.05. As I mentioned in last week's Monday Morning Outlook, the late-Friday rally from 2 weeks ago put the bulls back on life support.

I discussed the 3 consecutive days in which the International Securities Exchange all-equity call/put ratio fell below 1.0, and the fact that the CBOE Market Volatility Index (VIX) traded at a premium to its 20-day historical volatility for the first time since October 10. As we now know, that build-up in short-term fear preceded announcements from President-elect Obama regarding members of his economic advisory team. Moreover, and perhaps more importantly, the government came out with 2 additional measures last week to ease the credit crisis: the $200-billion term asset-backed securities loan facility to help unclog consumer and small-business-related loans, and the $600-billion government-sponsored entities purchase program designed to target mortgage-backed securities at Freddie Mac and Fannie Mae.

The latter action pushed mortgage rates down, with the benchmark 30-year fixed rate at 5.76% heading into Friday, down from 6.77% only 4 weeks ago. Plummeting mortgage rates are the first major tailwind for the housing sector in quite a while. The culmination of this bottled-up fear in the market and the government action resulted in a huge rally in the SPX last week, further justifying our advice about positioning oneself for an "anything can happen" outcome.

Historically, the bulls can garner some encouragement from last week's price action. When the SPX notches a 1-week gain of 7% or more, the following 3 weeks to 3 months have proven extremely bullish for stocks. Specifically, the SPX returns, on average, between 2.47% and 9.13% during the 3-week to 3-month time frames following a 7% or greater move.

So, could we see a repeat of these types of returns in the weeks and months ahead? Most certainly, as we saw some heightened fear ahead of a catalyst that created a tailwind for the housing and refinance market. At the same time, keep in mind that volatility in the market is at historic highs, so exaggerated short-term moves may be less meaningful in their implications.

Moreover, the new measures designed to address asset-backed loans and mortgage-related securities are not due to launch until February 2009. With the aforementioned tailwinds in mind, the issue of hedge-fund redemptions still looms. In the blink of an eye, forced selling could once again engulf the market, sending stocks spiraling lower.

As we enter this week, we see potential resistance for the SPX at the 965 level, site of its 50-day moving average. Last month's high at 1,000 is also a level at which sellers could emerge. On the downside, the 850 level on the SPX could be supportive on pullbacks, as this marks the site of the October lows.

Should 850 break, we would prepare for a retest in the 768 or 788 levels, site of the 2002 low and half-high of October 2007, respectively. If you are looking for a sector to dip your toes in on the long side, we would recommend the housing sector, with stocks such as Meritage Homes (MTH) and Toll Brothers (TOL) rising to the top. Meanwhile, continue to avoid energy, technology, and pharmaceutical stocks.

Indicator of the Week: Nova/Ursa Ratio
By Joe Sunderman, Vice President of Financial Market Analytics

Background: A sentiment indicator that we monitor each day is provided by the Nova and Ursa funds from the Rydex Series Trust. The Nova fund is designed to have a target beta of 1.5. In other words, using equities, stock index futures contracts, and options on those securities and futures, the fund has a target performance benchmark equal to 150% of the S&P 500 Index (SPX). Traders who invest in this fund are considered bullish on stocks. Meanwhile, the Ursa fund is designed to provide a performance inverse to that of the SPX by using a combination of short selling and options on stock index futures. Investors in this fund are considered bearish on stocks.

Data Interpretation: We can get an accurate view of the sentiment picture by comparing the amount of assets in each fund. Specifically, we divide the total adjusted assets in the Nova fund by the total adjusted assets in the Ursa fund to arrive at a Nova/Ursa ratio. A high Nova/Ursa ratio indicates an extreme amount of optimism (everyone investing in Nova⇒⇒ bullish fund). A low Nova/Ursa ratio indicates an extreme amount of pessimism (everyone flocking to Ursa⇒⇒ bearish fund). We have frequently found that lows in the Nova/Ursa ratio precede rallies in the SPX, while peaks in sentiment will often front run a decline in the index.

Current Reading: Below is a graph of the Net Asset Value Adjusted Nova/Ursa Ratio. The current reading for this sentiment measure is 0.89, meaning the adjusted assets of the Nova Fund amount to 89% of the adjusted assets in the Ursa Fund.

Implications: Concerning us at this moment is the promptness of Rydex fund speculators moving assets from Ursa Funds (bearis