The debt deflation trap

No matter how you look at it, the simple fact remains that we are still trying to inflate our way out of the ’09 “recession” (considering the state of things as well as government and fed action, was actually the second great depression).  This is blatantly obvious with the amounts of quantitative easing and “easy” monetary policy we have seen across the globe.  Central bankers are trying to avoid insolvency.

Crises, although each is different in its own way, have a tendency to follow a pattern.  They begin with an economic boom of some kind which leads to a rapid expansion of credit.  This is usually followed by a credit “crunch” at some point as the quality of the loans degrade and eventual bankruptcies from the bad borrowers come to hit the lenders (I use “bad borrowers” not to imply that it is the borrowers or the lenders fault necessarily but to describe the default of the repayment).  This leads to a drop in asset prices as distressed borrowers attempt to “de-lever” (pay off their debt) by selling anything they can and usually at a low price.

As asset prices fall, so does GDP which triggers problems with government debt repayments.  When de-leveraging ensues so does the appreciation of the country’s currency as consumers distrust other investments and move to cash, this is deflation (while good for the consumer it is bad for the country as a whole.  It hurts more than it helps but so does inflation.).  With a deflationary environment, the government actually has less money to repay their debts and thus insolvency occurs (look at Greece, since they could not inflate their currency and thus avoid this they are in the “trap” and thus, at current, insolvent).

From the ’09 crisis, however long ago that was, we appear to be in the later stages of the crisis cycle.  It could be said that we are not out of the woods yet and central bankers know this.  For the U.S., low rates until 2014 could be a conservative estimate considering our massive national debt (15 trillion at current, I think.)  With our debt at these levels, even with the ability to print money, we could be facing the possibility of tail spinning into insolvency.  The debt/deflation trap is what Bernanke is trying to avoid but unfortunately it appears as though, if we are not already experiencing it, we are headed for a period of “stagflation”.

Value Incentive for Repatriation

                It has been widely reported that corporations are sitting on massive profits that are mostly just sitting overseas.  This is not so much a problem as it is a shot in the foot of our recovery as money that could be invested in our country and people, is more or less, floating in foreign accounts.  There are two ways to bring these funds “home” or repatriate them. One doesn’t encourage investment in the recovery, i.e. create jobs, but would bring them “home”.  The other is a value incentive that would almost require job creation and growth.

                It has been argued that a tax incentive to repatriate would cause companies to bring those funds back to American soil and that that money would then be invested in the American economy.  This is only partially true.  A tax incentive would bring said funds back to America but would not likely be added to the economy through job creation and growth but would most likely be used for share repurchases, executive bonuses, and balance sheet bolstering.  None of these things add anything to the economy but rather distort the markets ability to be an accurate reflection of the economy.

                I would argue that the issue with repatriation is that there is no value incentive for companies to repatriate.  What I mean by that is that our currency is, at the moment, more valuable overseas than it is here and if that were to change we would see repatriation of funds, job creation, and growth.  The taboo of this idea is that a value incentive would ultimately mean deflation of the money supply.  I call this a taboo because a deflationary stance would cause a flight from equities into treasuries (risk off).  In other words the market would deflate as well.  Not good for the market. But at the same time companies would, more or less, be forced to invest in American jobs and grow their companies here in order to regain lost earnings that had been drawn out from the market.

This is Our Problem and We Can Fix It, Europes Another Issue

            As money is historically, and practically, a public good in terms of the value of labor we must have a rebalance of distribution in percentage terms at least.  Over the last thirty years, my entire life, we have consistently seen executive pay, compensation, and corporate profits soar and outpace inflation by a ridiculous amount while wages have remained stagnant and outpaced by inflation.  As a public good, it is the government’s responsibility to adjust distribution.  Since only the market can determine price through a supply demand metric the only way for the government to do this is to adjust taxes and or rates for a more equitable distribution of money.  Problem is that with inflation outpacing wages we have come to a point where people are less able to afford the inflated price of goods without seeing an increase in wages as the real value of goods is no longer reflective of the real value of labor.

We Need a New “ism”

         

                Throughout the course of human history we have tried many governing styles or “isms”.  We have learned that many of which sound like they would be a good idea but in practice ultimately fail for various economic conditions and social issues.  As we continue I will list various isms as defined by Merriam Webster and discus the pros and cons of each and explain why they don’t work.

                I will start with Marxism as it is seldom heard of and the most likely misunderstood.   Marxism is,

the political, economic, and social principles and policies advocated by Marx; especially : a theory and practice of socialism including the labor theory of value, dialectical materialism, the class struggle, and dictatorship of the proletariat until the establishment of a classless society http://www.merriam-webster.com/dictionary/marxism.

As a form of government this “ism” is perhaps the most socially acceptable as it takes into account fairness and rewards for those that do more than others.  It does end up falling into the category of some of the other “isms” in that the old adage holds true “absolute power corrupts absolutely” and groups of any scale are susceptible to this as well as individuals.  Once there is a dictator in power in line with bringing the “classless society” into fruition, it stalls out there due to the fact that the man in power will have no desire to relinquish said power.  We have seen this play out in other isms throughout history time and time again.

                The “ism” that is more of a transitional idea that leads to other “isms” is the one that is most demonized, and altogether misused in American politics today and that is socialism. 

Any of various economic and political theories advocating collective or governmental ownership and administration of the means of production and distribution of goods.  A system of society or group living in which there is no private property.  A system or condition of society in which the means of production are owned and controlled by the state.  a stage of society in Marxist theory transitional between capitalism and communism and distinguished by unequal distribution of goods and pay according to work done http://www.merriam-webster.com/dictionary/socialism

This “ism” is representative of the “needs of the many” idea.  That is, what is best for majority of the population should (and I stress that as things never work as they should) be best for the given society as a whole.  Again, we fall into the moral hazard issue that plagues “ism” after “ism” and as socialistic ideas take hold, especially in a democracy, it begins to run out of control as the people want more and more and ultimately bankrupt the government.  California is probably the best modern example of this although it is not a socialist government by definition it has adopted enough socialistic ideas that we are seeing the down fall of this “ism” as well.

                The “ism” that is the evolved form of socialism and the direct opposite to our current “ism” is the idea that there should be no private property and everything should (stressed again) be distributed equitably by the state is, of course, communism.  As an idea, it sounds like a good idea as it is based on fair distribution of resources.  It also remains the only “ism” that I know of that lead to directly to war, not fought by soldiers but fought by ideas.  Communism, as defined is

                A theory advocating elimination of private property.  A system in which goods are owned in common and are available to all as needed.  A doctrine based on revolutionary Marxian socialism and Marxism-Leninism that was the official ideology of the Union of Soviet Socialist Republics.  A totalitarian system of government in which a single authoritarian party controls state-owned means of production.  A final stage of society in Marxist theory in which the state has withered away and economic goods are distributed equitably http://www.merriam-webster.com/dictionary/communism.

We have seen it fail in Russia with the dissolution of the USSR in that what is equitable for most is not economical and leads to bankruptcy of the government, especially with the scarcity of resources, and that has a tendency to lead to unrest.  There were two main factors that lead to the down fall of the USSR’s communism in that they were faced with said scarcity and the ongoing theme of the moral hazard present in all “isms”.  We have seen that communism can and does hold on when there are abundant resources and when paired with another “ism” as we see today in China.  As China is a communist country with abundant resources with a hint of our current “ism” has become one of the most powerful economies in the world but does exhibit favoritism as moral hazard rears its head. 

Fascism, the most repugnant of all isms, often comes about as a result of the popularity of Marxist ideas and the desire for equality amongst the people.  It does however, perfectly depict the moral hazard within Marxism and indeed all “isms” in that it is the point where the person in power refuses to give it up and becomes a dictator and the following definition in itself is the best argument against it.

Often capitalized : a political philosophy, movement, or regime (as that of the Fascisti) that exalts nation and often race above the individual and that stands for a centralized autocratic government headed by a dictatorial leader, severe economic and social regimentation, and forcible suppression of opposition http://www.merriam-webster.com/dictionary/fascism.

 

Which brings us to our current “ism”, capitalism.  Wherein, all most everything is privately owned and distributed in a supply/demand fashion.  In other words you work for your capital and spend it as you see fit.

an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market . http://www.merriam-webster.com/dictionary/capitalism.

This is by far the most economical in that demand driven desires are worked out and achieved in a more or less free market fashion.  It has worked and at the moment continues to work but there are several issues that need to be addressed.  The problem is that money walks, talks (at least it does now that the Supreme Court has ruled it a form of speech) and shits on those who don’t have it.  What we have been seeing is that moneyed speech has been writing governmental legislation that benefits only those with it.  Furthermore, we have been seeing the marginalization of the working class where the largest corporations have been seeking out ways to lower their bottom line any way possible.  We have seen this in the efficiency of production where the automization of production lines eliminates the need for workers thus reducing costs.  Unfortunately this has begun to lead to fewer and fewer people controlling more and more of the wealth.  As this happens, the people without money, or at least less of it, are capable of buying less and less which in turn leads to them spending less and less.  These issues would not be as much of a problem if the free market where allowed to act in such a way that it would rebalance, usually through deflation and less demand.  However, the moneyed interests that have been, for lack of a better description, controlling government have been keeping inflation and wages at a somewhat steady rate while their profits rise nearly exponentially.  Recently though, we have been seeing actions perpetrated by the federal reserve bank (the Fed) that have been pushing inflation higher and benefiting only the corporations in that when inflation rises commodities prices fall (lowering cost of goods sold) and funds are forced out of cash and into equities (stocks) boosting share prices and thus earnings.

                As we have seen, no “ism” is perfect.  This is probably due to the fact that people are fallible and somewhat greedy.  Which is why I think that we need to try a new “ism”, either that or attempt to tweak the one we are currently using in such a way that avoids the pitfalls of each while using the benefits of all to make it the best possible.  We do call ourselves a “melting pot” as in a combination of many peoples and beliefs.  Maybe it is time to stop demonizing an idea because it is politically convenient and start melding together ideas instead of going elementary school and saying “I’m right, and your wrong”.

               

MF G..ive Me My Money!

                Not a whole lot happened in the market today as is obvious from the day’s price action.  We moved up a little, we moved down a little, and closed near flat on the day.  This price action formed what is referred to in candlestick patterns as a doji.  This pattern combined with yesterday’s long real body forms a two day pattern called a harami cross and has the potential for reversal.  Confirmation of this being a reversal would be a confirming close below today’s high.

                Not even the economic data moved the market.  Both initial and continuing claims came in worse than expected, but the ISM and construction spending came in better than expect (marginally, but don’t tell CNBC they thought that those numbers were great).  Not really all that surprising that we had something of a tug of war over those numbers but one would think that the swings would have been greater.  We also saw increases in auto sales although it was mostly business spending as they had to replace fleet vehicles.

                What actually plaid out as the biggest news in of the day was the senate hearing held over MF Global’s bankruptcy.  For those who don’t know, MF Global went filed for chapter 11 bankruptcy back in October.  What remains so controversial about this is not the bankruptcy itself, but the fact that customer money was missing.  Not investments that customers made which have been mostly returned, but money that was in cash accounts that shouldn’t have been touched.  It started out that about 600 million dollars was missing and the deeper they looked the more came up missing.  The largest estimate that I heard was that there was somewhere around 1.2 billion dollars.  It has been suggested that the company used customer funds without their permission for the firm’s investments in European sovereign debt.  The other possibility is that it was outright stolen.  I don’t know what would be worse, whether it was one guy, or if it was the entire firm.  I really hope that this gets sorted out soon and their customers get most of their money back.

Central Banks Save the Day…….For Now

          

                Let’s start with the news of the day which was a worldwide coordinated central bank action to provide liquidity to European banks.  Yay, were saved right? Wrong.  What this actually signals is that European banks were basically not lending to each other.  This was the same thing that spurred the selloffs and consequent market crashes in ’08.  If anything we should take this as an early warning of bad things to come.  That being said, we continued the rally from Monday adding over 4% across the board.

                The economic data came in as follows:

                                MBA mortgage index -11.7% Vs. previous of -1.2%

                                Challenger Job Cuts -12.8% Vs. previous of 12.6%

                                ADP employment change 206k Vs. previous 130k (revised from 110k) beating                                                                     expectations by 81k

                                Productivity for Q3 2.3% Vs. previous 3.1% missing expectations by .3%

                                Unit labor cost -2.5% Vs. previous -2.4% missing expectations by .4%

                                Chicago PMI 62.6 Vs. previous of 58.4 exceeding expectations by 5.1

                                Pending Home Sales 10.4% Vs. previous of -4.6% exceeding expectations by 10.3%

                                Crude inventories of 3.932 m Vs. previous of -6.219 m

                I’ll let you decide what the numbers mean as they are mostly mixed with the exception of the mortgage index, job cuts and pending home sales, and can be interpreted in many ways.  What was probably more important was the Fed’s “beige book” which is a compilation of economic data that the Fed has been looking at to determine the general state of the economy.  The beige book pretty much said that the economy was growing at a “slow to moderate” pace.  Nothing we didn’t know already but points to things being, again, worse than the above numbers seem to indicate.  Two possible things are happening here.  One, things are actually getting better and we should be confident in the markets.  Or two, things are being skewed by some people taking advantage of the economic situation.  I am more inclined to believe the second.

                I should also mention that China eased its reserve requirements for its banks.  Is this good or bad?  I’m not really sure.  I seem to recall that until the European crisis became the main focus, we had our attention fixed on the Chinese economy and every time there was a hiccup in the data our markets would turn down on fears that China was slowing.  This is just evidence that, yes, they are slowing and they are trying to keep it going by any means necessary.  Their rate of inflation should be a very clear sign of that.  

Where to Start….Hmmm

               Let’s begin with U.S. economic data that was released this morning.  Biggest market mover was the consumer confidence number that came in at 56 versus 39.8 which beat expectations by 13.5.  An absolutely huge boost to confidence, right? Not really.  As it turns out, the consumer confidence number reported today is actually from October.  I seem to remember a large rally in October which was likely the reason for the boost.  Probably more telling was the Case Shiller number that came in at -3.6% versus -3.8% which shows a modest improvement but missed expectations by .6% on the downside.  That number was mirrored by the FHFA price index coming in at .9% versus -.1% prior, beating by 1%.  Over all, the U.S. market data remains overshadowed by Eurozone concerns.

                Out of Europe; a bond auction, more rumors, and red flags.  The Italian bond, auction which was expected to be abysmal, beat expectations in terms of demand.  Yeah, hooray, people will still buy Italian bonds, however at historically high and unsustainable yields.  The 3 year yield came in at 7.89% and the 10 year at 7.56%.  Later the rumors began to fly that the ECB and IMF were looking to leverage the EFSF by 2.5 times which on the upper end of the spectrum should bring about 625 billion euros.  Not only is this the 4^th time (I think) that this rumor has been floated, but it wouldn’t be nearly enough.  600 billion might, might be enough for one of the PIIGS but not for all of them.  And then, the OECD (Organization for Economic Co-operation and Development) came out and cut European forecasts and warned of a possible Eurozone breakup.

                So U.S. data, with exception of the lagging Case Shiller, was rather lackluster.  Italian bond auctions weren’t terrible but were still bad.  Rumors of a solution were being recirculated although they had already been refuted and would be ineffective even if true. And rate cuts, downgrades, and possibility of a breakup of the Eurozone.  Oh my.  Maybe we need us some ruby slippers, a tin man, a scare crow, and a cowardly lion.