Editorial

"The recession ended in June": Dennis Kneale

"The recession was definitely over in September": Any one of a number of people.

Ok.  Let's say that I accept all this at face value, even though while driving through my definitely-beach-oriented local town here this afternoon I noted even more closed-and-gone storefronts than there were a couple of weeks ago, and last night at the local open-air mall, although the evening was absolutely gorgeous, you could have fired a 155mm Howitzer down the "main drag" without killing anyone - because there was almost nobody there, and literally not one shopping bag was in evidence.

I simply have to ask the pundits and the carnival barkers, of which CNBC is the worst (but certainly not the only sinner) the following - why do we need any of these programs if in fact the economy is growing again:

• Zero interest rates from The Fed.  Isn't 2%, 3%, 4%, 5% more consistent with economic growth?  If indeed the economy is expanding, why do we need "funny money"?
  
  
• $8,000 home-buyer tax credits.  And not just first-time credits either - those were recently expanded, and the NAR has said quite clearly that "but for this program housing would collapse."  Is this consistent with an economic recovery?
  
  
• FHA underwriting mortgages at 3.5%, their default rate is going parabolic, their reserves are down to well under half of the mandatory minimum and there is no evidence in sight that their performance metrics are improving.  With the aforementioned $8,000 "credit" and the FHA's willingness to monetize it, you can once again buy a home with "zero down", just as we did in the bubble.  Is this consistent with an economic - and housing market - recovery?
  
  
• The dollar carry trade.  It's obvious and starting in June of this year the correlation between the dollar's move and the S&P 500 became nearly 100% on an inverse basis.  Consumer confidence numbers were far below expectations Friday, yet as soon as that hit the dollar, the market rose - into worsening economic data.  Again, is this consistent with an economic recovery?
  
  
• "Cash for clunkers" - and oh, by the way, what happened to auto sales when it ended?  Is the near-vertical drop-off in GM's sales as soon as the program ended consistent with an economic recovery?  Is a claimed 10m expected 2010 units consistent with economic recovery when in 2005 and 2006 the industry sold nearly 17 and 16 million vehicles, respectively?
  
  
• 29.9% interest rates on credit cards via "jack-up" letters and other outrageous actions.  Again, is this sort of gouging consistent with economic recovery?
  
  
• Declining consumer credit demand.  I've published the graph before and will reproduce it below.  Is this consistent with economic recovery?
  
  

The Carnies and other Barkers have their desire to make you think things are just peachy.  Then again, so did Japan after their debt-fueled property crash.  The Nikkei surged on the back of the carry trade, just as has the S&P 500.

But a huge part - perhaps even the ultimate cause of the meltdown that took our stock indices down some 60% from their highs from October 2007 to the spring of 2009 - was the unwinding of that very same Yen carry trade.

The dollar-based carry trade, when (not if) it unwinds, will do even more damage than the Yen-based carry did.  And unwind it will.

Remember that everyone was certain that the Yen would not unwind, because Japan was not going to raise rates "any time soon."  They in fact didn't raise rates but it didn't matter - as soon as the first person yelled "FIRE!" the entire game came apart, as the unwind was self-reinforcing and margin calls produced yet more margin calls.

PIMCO has talked about "sugar highs" boosting the stock market.  The problem with sugar highs is that they wear off, and worse, they're full of calories and thus make you fat, destroying your ability to be mean and lean - to run and change direction quickly - later on.

Consumers are having none of it.  Confidence came in dramatically below expectations, and the reason is simple: there are no good-paying jobs unless your idea of "employment" is playing games with other people's money by being an "investment banker."  Call centers are all over in India, manufacturing is all over in China, we've got Starbucks coffee-servers, McDonalds' burger flippers and WalMart "greeters" - all jobs that pay 1/4 what the old manufacturing jobs did.

The funny thing about all of this is that one of the chief barkers Tweeted me yesterday to ask if I was "still selin (sic) doom."

First and foremost, I don't sell anything.  I don't run other people's money, and The Ticker is free.  Unlike the barkers and their crowds, I don't depend on the advertising dollars of stockbrokers (just watch CNBC for an hour and catalog who butters their bread!) to survive.

Second, as I have repeatedly noted, I was an unabashed Bull from 2003-2007.  Why?  Because the economic numbers were there to back the advance.  Oh sure, it was a liquidity-driven move, but the fact remains that 2000-2001 wasn't even a recession from a consumer point of view - there was no over-levered consumer problem, there was no issue with debt defaults in housing or credit cards, and consumer credit y/o/y never went below zero on a rate-of-change basis. Indeed, even approaching zero has only happened during severe recessions, as the following chart shows:

There was reason to be bullish coming out of the 2001 time frame.  The Federal Reserve programs worked - they spurred economic activity - real economic activity by real people - as is evidenced by the above graph.  Consumer credit consumption spiked higher, then leveled off at the 5% growth run rate - exactly as intended by The Fed.

While the policies put in place sowed the seeds of our current disaster in the short term they were effective.  But those same policies - zero interest rates (nearly so in 2001, truly so today) have failed to send consumer credit consumption - and true economic activity - higher.

Why not?  Because in previous recessions we had a buffer between the carrying capacity of debt and the total amount outstanding in the consumer and business world.  This is evidenced by the fact that these previous busts were inventory-led, not credit led.  That is, they were a matter of oversupply in the market (e.g. the Nasdaq bubble, etc), not excessive leverage - that is, too much debt for the income available to service it.

In 2007 the latter situation asserted itself.  That made the tonic prescribed by Bernanke and pals ineffective.  They tried it anyway, and they continue to do so - even though there is no evidence that it has - or can - work.

The M1 "Money Multiplier", after appearing to stabilize just below 1.0, has resumed it's plunge.  The tonic that was allegedly going to restore credit creation in the economy - the raw printing of money via "Quantitative Easing" - has done no such thing:

China has woken up to the danger of the US Dollar Carry, as evidenced here:

“The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation,” he told reporters in Beijing today at the International Finance Forum.

Liu said this has “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

His view echoes that of Donald Tsang, the chief executive of Hong Kong, who said the Federal Reserve’s policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis.

“I’m scared and leaders should look out,” Tsang said in Singapore Nov. 13. “America is doing exactly what Japan did last time,” he said, adding that Japan’s zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown.

Yep.  It did not work in Japan and it won't work here.  You cannot fix a drunk with a case of whiskey, and you cannot solve a credit-led problem with more credit - that is, more debt.

You can't replace consumer activity with government borrowing for very long.  You can try in the short term but it won't work in the intermediate and longer term. More proof is found in our trade balance, which despite massive dollar devaluation is now at the worst since January, while the dollar has plummeted.  Dollar devaluation was supposed to improve our balance of trade.  It failed to do so, just as the printing of money has not spurred credit creation and capital formation as we were told it would.

It would be nice if the policy prescriptions followed thus far could work, but in a saturated debt market they cannot.

All modern monetary systems are credit-based.

This is about mathematics, not "feelings" or "beliefs."

All we have now is the carnival barkers claiming that "prosperity is returning!" even while storefronts are darkening and debt is defaulting.

It hasn't worked this time, and the policymakers know it, just as they knew it in 1930. 

But policymakers didn't stop lying in the 1930s and it appears they're not going to now.

If any of the policymakers believed what they were selling neither the $8,000 homebuyers "tax credit" or the zero percent Fed Funds rate would still be in place.

More than two years into this mess with myself and a few others warning that the policy path elected was both futile and destructive, we are finally seeing foreign governments wake up as they realize that Japan's ZIRP was bad, leading to two bubbles and then crashes in the global equity markets and one in property markets that served up enormous pain. 

If we don't stop with our boozing on "free money" for the banksters (which is NOT filtering to the common man!) the resulting crash will have consequences for our nation and indeed the world akin to liver failure rather than a hangover.

Bernanke and the United States Government must stop their madness, and do so today.  We have done nothing but made the pain and "creative destruction" that must come worse than it would have been in 2007, and far worse than it would have been in 2000.

Those who made the bad loans cannot be protected from their foibles and the just consequences of their bad decisions.  We must ring-fence the Federal Government, withdraw the excess liquidity, and force rates high enough to kill the dollar carry - even if it hurts.

It is better to lose a limb than your life. 

In economic terms that's the choice folks; the gangrene is spreading and if we do not amputate it will reach our torso. 

If it does our economic and quite possibly our political system will die.

William Pesek opines:

Barack Obama sure has lots to discuss on his maiden voyage to Asia as U.S. president. Yet all this is just conversation compared with the real issue on Asia’s mind: a wobbly dollar that’s putting the region’s money at risk.

Think of this trip as a visit to America’s banker, and an unpleasant one. Asia wants assurances that the U.S. can repay its fast-mounting debt and prevent a dollar crash. The reality dawning on Asia is that Obama can’t offer them such a pledge -- not with U.S. borrowing so out of control.

Unfortunately this sort of misdiagnosis is common - that The US is borrowing in an "out of control" fashion on its own initiative.

Nope.

America could not dream of borrowing $2 trillion a year in new commitment, and meeting the debt service on $14 trillion (current + next year's deficit), if interest rates were at 10%.

This simple fact puts the lie to any claim that we have an "independent central bank."  We have no such thing, and as a consequence all the whining and crying about "Audit The Fed" bills is not just misplaced - it is an outright misdirection and scam.

The Fed has never truly been independent, save once - under Paul Volcker.  Never before or since has The Fed acted without due regard - on its knees if you will - before Congress and The Administration.

Volcker did it because despite the heat he knew he would take (and he did) it was necessary.  This is where the much-vaunted "independence" claim has arisen from.

But that was one man, not a structure.

It was one person with conviction and willpower, not the pantywaists that now infest The Fed.

I have often opined that the issue is not now and never has been a gold standard or lack thereof.  Hard money monetary systems have been subject to the same "boom and bust" nonsense that we have experienced since the 1970s, and in fact, they were just as common and often more damaging.  1873, for example.  Or Tulip Mania.  South Seas bubble?  Asian Tiger?

The problem is always the same - what I call "The Wimpy Syndrome".  Left to their own devices, politicians, when confronted by a desire to spend money they don't have, will always resort to eating the hamburger today and trying to pay next Tuesday.

The theory behind an "independent" central bank is that it is supposed to be immune to The Wimpy Syndrome, in that it can control borrowing costs through liquidity actions.

That's a mighty big knob they got....

No, not the monetary policy one.  The other one - attached to Dodd, Frank, Obama, Ways and Means, Pelosi (well ok, not Pelosi) and Reid.

Since Volcker's time at The Fed the executive and legislative branches have willingly turned a blind eye to the scam machine known as "Wall Street."  Oh sure, Wall Street has legitimate functions - capital formation is important, as is floating bond sales.  No problems there.  The issue comes about when the 50 basis points is no longer enough and greed starts to press people to look for 55, then 60, then 100 - and the only way to do it is to lie, cheat and steal.  The campaign coffers fill up and the byzantine world of Federal Law and Regulation come out to protect the cheaters, even if only by obfuscation.

Likewise when the politicians want to spend more money.  Normally you'd have to tax more to spend more, but that's not politically acceptable.  So we float some more bonds, claim everything is ok, and off we go spending money we don't have. "Deficits don't matter" becomes the mantra, and despite the fact that many Democrats bemoaned Dick Cheney mouthing those words, President Obama and Pelosi's House have done nothing to change that viewpoint.  Instead they have accelerated the unsupportable spending - full throttle.

What is supposed to happen to scammers is that when they get caught they go to pound-you-in-the-butt Federal Prison (not the "Club Fed" golf outing style) and the companies they run lose their corporate charter, as (effectively) did Arthur Andersen. 

What is supposed to happen to the government when it tries to spend more than it makes is that the "Bond Market Vigilantes" show up.  That is, to fund ever-rising debt the bond market will ordinary demand more and more coupon (interest), thereby serving as a brake on unsustainable government spending trends.

This presumes The Fed doesn't interfere in the latter, and the crooks don't manage to find the means (legal or not) to get The Federal Government to ignore their scams.

That's a very nice fantasy you see there Mr. Magoo.

So let's cut the crap.  If the Asians don't like us borrowing so much money stop lending it to us.  Cut the crap with the circle-jerk mentality that mercantilist political schemes are in some way compatible with honest and fair dealing.  They're not, any more than the vendors in Shanghai hawking software .et.al. are all selling "fully licensed and legal copies."

This nonsense about the dollar ever having been "safe" is a bad joke.  Certainly the corrupt politicians in China, Japan and elsewhere are well-aware of the principle of seigniorage - that is, the "value" of money less the cost of printing it.  Why would they believe our political machine wouldn't exploit the very tool they have used themselves?  Such hubris.

At the same time if The Fed and its members are "concerned" about the destruction of the only thing they have to sell (dollar-based credit) then pull the system liquidity down until rates move higher.  A lot higher.  Keep doing it until the crap stops - until Congress either stops spending or the auctions fail and they're forced to cut it out and the carry trade is made unprofitable and thus is unwound.

The issue is not now and never was about the economy.  When I ran MCSNet I could have grown the company 10x faster by using leverage - that is, debt - than operating on a cash basis.  I refused, because while I might have wound up with 10 times as much money, I might have also wound up with a big smoking hole in the ground where my firm once was.  Debt is not necessary, other than self-liquidating trade credit, in the operation of a firm, and indefinite geometric growth is not possible in any space of finite resource - like this rock of finite size we all live on.

That doesn't mean there aren't responsible uses of debt.  There are.  But playing Wimpy writ large to the tune of $12 trillion dollars isn't one of them, nor is operating a financial institution at 20, 30 or 40:1 leverage (that is, with just over $2 in capital for every $100 in "assets".)  The latter only makes sense if you have reason to believe that if you blow it (remember, as little as a 3% loss in such a situation wipes you out!) the taxpayers will step in and "save" you.

That's exactly what they both expected and got for the most part, right?

Economic contraction isn't necessarily bad, nor is deflation.  Both can be, but both squeeze out the bad actors - the scam artists and those who simply promised the impossible - and make them pay through bankrupting them.  That's exactly what is supposed to happen on a somewhat-regular basis, and in fact it is necessary to have a sustainable economy - the scammers and imprudent need to be flushed on a regular basis or they crowd out all the legitimate business people (after all, you can always make more money stealing!) until only the scammers are left!

Until either Asia or Bernanke grow a pair, shut their jawboning, lying yaps about "concerns" and act we will see no meaningful change - or reform. 

That is, you, the average American, will continue to be asset-stripped, you will see your real standard of living decline, and ultimately, you will be tossed into the street and onto the public dole, until that too collapses under its own weight.

Welcome to reality.

For two and a half years The Market Ticker has pointed out the foibles of The Fed and other claims of "help" for the economy - when the prescription for "help" is just an extension of the same failed policies that created the mess in the first place.

But now we are starting to see this show up in the so-called "mainstream media", with the latest being The Wall Street Journal:

It takes similar reasoning to reconcile the elation felt across America every time the stock market rises—partially replenishing personal investment portfolios and 401(k) retirement plans—with the uneasy feeling that we are being set up for yet another big financial disappointment. We dare to hope that the economy is growing solidly once more, that the Federal Reserve has superior knowledge about providing liquidity, and that the U.S. Treasury knows what it's doing by guaranteeing money market-fund assets.

But what if the Fed's efforts to stoke a recovery are merely creating asset bubbles in equities and elsewhere? What if government guarantees—explicit and implicit—are encouraging high-risk investment behavior rather than restoring conditions for normal market returns? What if excess dollars produced here are being channeled by speculators into foreign stock and bond markets as part of a currency play?

No, really?  Did you get that from the correlation charts of the dollar and S&P 500?  You know, this one, showing correlation from March onward:

Judy continues to opine:

Deflation is seen as the bugaboo of Keynesian economics. But it can actually serve to spur economic activity as lower prices enable struggling consumers to get back in the game, and enterprising individuals can build businesses using tangible assets that yield valid profits.

But the Fed seems to think that prices should only go in one direction—up—no matter the circumstances. It's this bias toward inflation that is revealed by the FOMC's reference to "stable inflation expectations"—which is less a paean to price stability than an inadvertent oxymoron.

What Judy misses (perhaps because she's unaware of it, or perhaps because she simply doesn't feel comfortable saying it) is that deflation destroys over-levered debtors.  It forces them into bankruptcy.

When that happens to the "little people" (that is, you and I) it doesn't matter to the oligarchs and robber barons on both Wall Street and Washington DC. 

But defaults also destroy lenders who made imprudent loans.  That's unacceptable as a matter of Washington DC's bought-and-paid-for policy, which is why we have Treasury Secretaries and the Chairman of The Fed corralling Representatives and Senators in a room and literally threatening them with the collapse of America if they don't fork up $700 billion of taxpayer funds for an open-ended, one-page slush fund that includes absolute legal immunity for whatever might be done with it.

If this had ended at $700 billion it would have been bad, but it didn't.  No, The Fed then continued onward to announce the purchase of $1.2 trillion dollars (that's $1,200 billion more!) of debt and securities that, according to Section 14 of The Federal Reserve Act, they are not lawfully allowed to buy.  (Section 13.3, often cited as justification, only allows the making of loans - not the purchase of assets.  All purchase authority rests in Section 14.)

The FDIC then stepped outside of its legal mandate as well, "deciding" to guarantee bond issuance by banks - something that has absolutely nothing to do with depositor insurance.  Why?  Because once again, it is unacceptable in the Washington DC establishment if those who make bad loans - on purpose - have to eat them.  Only the borrower - that is, the "ordinary Joe" - is allowed to have his future destroyed.  The lender, who is supposed to also lose his money when he makes a bad decision (thereby providing a strong disincentive to making bad loans) is to be protected by the taxpayer, thereby screwing the borrower twice - first by bankrupting him, then demanding that he bear the cost for the lender who made the bad lending decision as well!

Keynesian Economics and it's offshoot ("Chicago" economic theory) is, at its core, a scam.  Not because the idea is invalid, but because it dictates that during times of plenty ("booms") the government must raise taxes and pay down debt - not just "decrease deficits."  Yet in the post-war era we have never managed to run a material surplus, not even during Clinton's years despite the claims of his boosters - he, like all other modern administrations, cheated by "banking" FICA and Medicare deposits (which are pledged against liabilities in the future!)  The boosters of Keynes refuse to discuss the fact that they're not even following his claimed theories, but rather are playing "black sharpie marker" with the parts they don't like.

Now here's the scary part: Even though more than half of all American households now own equities directly or through mutual funds, an increase in equity prices does not figure into the Fed's calculation of inflation. So while measures of core inflation (which exclude food and energy) carefully register minute gains in the price of a fixed basket of goods and services meant to reflect what a typical family buys to achieve a minimum standard of living, they ignore massive price surges in what has effectively become a widely held consumer good: stocks.

Moreover, the Fed's inflation-targeting approach overlooks price increases for real estate and rising commodity prices. Don't even mention gold, which has gone from $707 to $1,114 since a year ago.

Of course not. 

But again, this is by design.  The Fed is intentionally applying the wrong standard for the construction of the monetary base, because if it were to not it would have to recognize the asset price moves that underlay the actual economy in its economic numbers.  This, in turn, would have led housing price increases to have been reflected in monetary aggregates and people would have freaked out starting in about 2004 - instantly derailing the bubble before it could get going.

As I have repeatedly argued if you get the original premise wrong everything else you do from that point forward is also wrong.

The monetary base in a credit-based monetary system is not "M0", "M1" or "M'" (M-prime.)  It is the unencumbered assets against which one is both willing and able to borrow.

Further, the definition of sound lending is not predicated on some leverage limit or wildly-distorted view such as Basel-II.  It is in fact very simple: if one never lends unsecured beyond one's capital there is never a systemic risk that can arise. 

Here's the problem with all the games once one gets down to brass tacks: you cannot screw people indefinitely and expect them to come back for more abuse.  Oh sure, you can occasionally con people a second time, but since these "big interests" rely on a continued volume of business.....

As just one example, how many municipalities will buy interest-rate derivatives from one of these "big banks" after the disclosure that Jefferson County overpaid by 400% - and a good part of that overpayment went to bribes?  Further, it has become clear that the municipal government didn't understand the risks involved - and one can reasonably presume that was because those risks were intentionally hidden - probably by the bribing parties, the recipients of the bribes, or both.

There are solutions here but it is increasingly obvious that if Government doesn't step in the market will.  All I have to do is look at volume - the percentage that is represented by "high frequency computer trades" has gone sky-high since last fall, yet volume has been dropping dramatically since March.

When the market degenerates down to a handful of trading houses with high-frequency trading computers passing the same 100 shares back and forth between themselves as the remainder of the market participants have gotten tired of getting reamed on a daily basis due to the cheating and decide to take their ball and go home, how do the "big trading houses" make money?

We're witnessing the destruction of the capital markets as the system is imploding from within as a direct and proximate consequence of willful blindness and outright fraud.

Just a quick note..... and quick chart - both from this morning.

10 handles came off the S&P 500 in less than 30 minutes (a 1% move) when the dollar strengthened by about two tenths of 1%.

What would be the impact of the dollar moving higher by 10%?

This is the problem with the carry trade.  The leverage that gets deployed, once it gets going, is typically in the range of 5:1, 10:1 or even more compared to the equity markets.  (Absolute leverage in the FX markets is frequently 100:1 - in fact, even retail traders can run 100:1 leverage at most FX brokers!)

Just remember folks, ZIRP and it's pals are always exploited by the politicians to issue debt "free" into the markets.  But once issued that debt has to be rolled over (since governments almost never run an actual surplus allowing them to pay down that debt), which means that the issue is not whether you can make the interest payments today, it is whether you can make them tomorrow given the possible changes in interest rates.

If interest expense ever exceeds income, you're finished, just as was the "buyer" who took out an OptionARM and then had his payment reset to more than his income.  Instant Boom.

The same thing happens to nations.

The problem is that nobody knows exactly where the line is, because that debt must be rolled, and it is the future cost of that rollover, not today's interest rates, that determine where the wall is.

Have we reached the wall?  Probably not yet.  But if we keep issuing debt into artificially-suppressed interest rates, we will hit it with certainty, and the carry traders are betting (successfully so far) that government will not stop issuing debt (spending more than they make) and Bernanke will not pull enough liquidity to cause short rates to rise by even 1 or 2%.

Better hope all those "ands" and "buts" hold up folks.

(PS, if you think they will: Sold to you.)

From this morning's open (there have been many essentially-identical charts over the last months...)

You can argue anything you'd like, but this - the chart of the SPX cash and the dollar, overlaid - put the lie to any claim that "there is no carry" at play.

Today, as with many days before (and I'm sure will be since) is stunning evidence that indeed there is a monstrous carry being perpetrated against the dollar and our nation, Bernanke knows it, and there is exactly one way to stop it.

Remove enough liquidity so as to cause short rates to rise where it becomes unprofitable - 2% should do it.

Bernanke is causing this trade to be intentionally put on, and the only people profiting from it are the big banks that can borrow at or near the fed funds rate. 

You and I are forced to borrow (if we want to, which we'd be nuts to do) at 29.9% on our credit cards.

This is just another means by which the big banking oligarchs steal your money America.

There is no actual "rally" in the stock market as a consequence of fundamental improvement in the economy.  Rather, the "rally" is a consequence of the dollar carry trade - a destructive Godzilla that has infested our capital markets as a direct and proximate result of Bernanke's and Geithner's policies.