Category: zerohedge

The title is deliberately provocative to relay the extent of my concerns with recent market action. Regular readers will know of my bearish long-term outlook for stocks based on the view that we remain in a secular bear market which began in 2000 and extraordinary central bank policies have only delayed an eventual bottom. But the recent activity in stocks and other asset markets is sending a clear signal that dangerous bubbles are building everywhere thanks to printed money and low interest rates. And central banks are unwilling to intervene as economic recovery remains as elusive as ever. The likely endgames are obvious enough: either recovery happens and central banks move too late to quell inflation or recovery doesn’t happen at all. Those forecasting a happier outcome either don’t know of the long history of consistent central banking failure or, more likely, are beneficiaries of the current policies.

Many commentators have rightly pointed out the froth building in the U.S. stock market with Twitter jumping 73% on debut, margin debt at record highs and extreme bullishness among institutional and retail investors. But the bubbles developing in Asia, arguably much larger in size not just in stocks but across all asset markets, have been largely ignored. Today’s post will focus on three red flags:

1. The Indian stock market reached record highs over the past week despite all of the country’s problems and a currency recently in free fall.
2. Australians have been increasingly using their superannuation funds as collateral to buy residential property, helping reflate one of the world’s biggest housing bubbles.
3. The Japanese bond market has effectively died with the government becoming the dominant player in the market due to its massive bond buying program. This isn’t just a Japanese phenomenon with central banks now owning a third of the world’s bond markets. Free markets, these ain’t.

I’ll also explore why the excesses are developing. And a key underlying reason, little acknowledged, is that the fiat money system – paper money without an anchor to something of solid value – is becoming stretched and perhaps reaching breaking point as central bankers print endless money without constraints. Some may see this as an extreme point of view but that ignores the relatively short history of the system and subsequent sharp increase in asset price volatility.

Asia Confidential isn’t so arrogant as to predict an imminent downturn in asset prices. No-one knows exactly how this will play out. But increasing asset price volatility would seem relatively assured. Given this, it would make sense to keep your assets diversified, resist taking on too much debt (asset price risk outweighs attractive rates) and, most importantly, avoid areas that investors are salivating over (such as hyped IPOs).

Red flags everywhere

If alarm bells aren’t going off for investors, they should be. And it’s not just the IPO of a certain social messaging company which is valued at close to US$24 billion despite never earning a dime. I saw one portfolio manager describe the IPO as a great thing and the best of capitalism in action. I’m not sure who’s more stupid: this investor, the Twitter founders who under-estimated public demand and left money on the table, the investment bankers who under-priced it or the retail investors who are holding onto the shares, which will probably go the way of RIM in a few years time.

The largest signs of excess instead lay in Asia. I’ve mentioned the Indian stock market reaching record highs. It was only in July that the country was in turmoil with a currency in free fall. Since then, stocks have surged, out-performing all other major markets in Asia.

Below is India’s Sensex index.

For the record, I advocated accumulating Indian stocks during the turmoil, but the market has run extraordinarily hard since then, making it prudent to take some money off the table.

The country’s problems haven’t gone away. The economy is still growing at decade-lows. The current account deficit remains one of the largest in emerging markets. And politics remain uncertain ahead of a general election next year.

Now some will argue that the stock market is just forecasting a better economy ahead. Maybe. But you’re starting point is a market at record highs, on a not-so-cheap 16x trailing earnings, arguably distorted by low interest expenses given low rates.

More prominent warnings signs are outside of stock markets though. Everyone knows that residential property prices remain elevated in the likes of China, Hong Kong, Singapore and Australia. The latter has taken it to a whole new level, however.

The latest trend is Australians using their superannuation as collateral to buy residential property, as well as other forms of property. Residential real estate now accounts for 14% of so-called self managed super funds. That’s helped drive an 8% year-on-year increase in house prices in September.

Now I’m not sure if the practice of using superannuation or pensions as collateral to purchase property is used in any other country but the dangers are pretty obvious. Particularly when many developed countries, including Spain, are raiding pension funds to finance their QE programs.

Australia has added risks given the extent of its housing bubble. Demographia says the Australian housing market is the most expensive in the developed world, with property prices at 5.6x annual income, with 3x or below considered affordable. Meanwhile, The Economist magazine suggests Australia is the world’s fourth most expensive housing market, with pric
es 44% overvalued versus rents and 24% versus wages (which are undoubtedly grossly inflated).

The risks to Australia from the inflated housing market are systemic also. Housing assets of A$4.9 trillion are 3.3x larger than Australia’s GDP. Moreover, residential property represents more than 60% of the big four Australian banks total loan books. Given these banks have an average leverage of 20x (equity/assets), it would take less than a 10% fall in residential property prices for equity in these banks to be wiped out.

One word comes to mind: bail-outs!

Lastly, there’s been unsurprising news over the past week that the Japanese bond market has become dysfunctional. I’ve previously talked about how the massive bond buying program of the Japanese central bank, equivalent to 70% of new bond issuance, would crowd out private investors and thereby significantly increase volatility.

Now one of Japan’s larger brokers, Mizuho, has come out to declare that the sovereign bond market is effectively dead. The firm’s chief bond strategist Tetsuya Miura told Bloomberg:

“The JGB [Japanese government bond] market is dead with only the BoJ [Bank of Japan] driving bond prices.

These low yields are responsible for the lack of fiscal reform in the face of Japan’s worsening finances. Policymakers think they can keep borrowing without problems.”

Recall that Japan is attempting U.S.-style stimulus on steroids to lift the country out of 20 years of deflation. It hopes to increase inflation without a rise in bond yields and interest rates. Rising rates would kill Japan given that interest rates of just 2.8% would mean interest expenses on government debt equaling all of current government revenues. An unsustainable situation.

Japanese government bond yields have behaved so far, though there was a huge spike in volatility earlier this year. Given the central bank has now effectively swallowed the bond market, you can expect to see increased volatility hitting headlines again very soon.

Below is a chart of 10-year Japanese government bond yields.

By the way, this isn’t just a Japanese issue. Central banks now own a third of the world’s bond markets. That number could substantially rise given plans for further QE. And it makes an eventual bond market revolt more likely at some stage.

The system reaching breaking point?

It would be easy to blame the above excesses simply on money printing and low interest rates. But that would ignore some of the key underlying causes. A few weeks ago, I highlighted how the significant trade imbalances between the U.S. and China played a major role in the financial crisis and subsequent policy.

But reading through the former publisher of highly-regarded Bank Credit Analyst Tony Boeckh’s book, The Great Reflation, has reminded me of a larger issue at play. Namely, the central role of the paper money system in increasing asset price volatility:

“The Great Reflation now underway should be seen as another chapter extending the long-running saga of inflation – excess money and credit expansion – that began in 1914. A hundred years of financial background may seem a little esoteric to some, but it is important to understand that we have been living for a very long time in a monetary world that is without an anchor. When there is no anchor, the monetary system has no discipline. And it is this lack of discipline that is fundamental to where we are now and where we may be going. The Age of Inflation is deep-rooted and enduring but it is not sustainable forever. Anything that is not sustainable has an end point. When that time comes, it will not be pretty.”

Boeckh goes onto explain the traditional anchor to prevent excesses was gold, and to a less extent, silver. In other words, central banks couldn’t print money without additional metallic reserves, prior to 1914.

The big change came in 1913 with the formation of the U.S. central bank, the Federal Reserve. The anchor with gold was gradually wound back until the seminal event in 1971 when the U.S. broke the link to gold and floated the dollar. This allowed central banks to print money without any constraints.

What that’s meant is that at the sign of any downturn, central banks have opted for the easy, most painless, solution: inflation. Which has resulted in increasing asset price volatility:

“The Great Reflat
ion experiment now underway, while critical in avoiding a 1930s debt deflation spiral, ensures that we are a long way from writing the last chapter on the post-1914 Age of Inflation. The managed paper money system has been a huge failure, and lies at the root of the persistent tendency to inflation, instability, and debt upheavals. There are obvious political advantages to inflation in the short run, and a paper system with no brakes is a great temptation to politicians with one eye always on the next election.”

It’s important to understand that Boeckh doesn’t necessarily predict inflation ahead. He views, as I do, inflation and deflation being two sides of the same coin as inflation always begets deflation and vice versa. Right now, you’re seeming asset inflation, but disinflation (declining inflation) in the price of goods (reflected in CPI numbers). Whether we get asset deflation or inflation flowing through to CPI remains to be seen.

And it’s imperative to realise that inflation doesn’t aid economic growth. This is contrary to the views of just about every economist on the planet. But the fact is that the U.S., for instance, experienced superior economic growth in the 19th century when there was practically zero inflation. And during that time, there were fewer economic downturns than has occurred over the past century.

The warped belief that economies need inflation for growth was aptly on display in a recent New York Times article entitled “In Fed and Out, Many Now Think Inflation Helps”. A more silly and misinformed article you won’t find readily, but it certainly furthers the agenda of the new Fed chief to keep on printing money in the hope of reviving the economy.

Getting back to Beockh and what he does suggest, and I totally agree with, is that the current paper money system is being stretched to breaking point. Consequently, you should expect heightened volatility in future:

“The fragile state of the economy and financial system will continue to require inflation of money and credit, heavy government intrusion into the private sector, and frequent resorting to subsidies and support programs. This will continue to distort relative prices of labor, goods, services, and assets. It will sustain the economy in an artificial state and will compound instability and make it impossible to understand what is real and what is not.”

If this is right, the question then becomes how best to protect your assets in what is likely to be a treacherous environment going forward. Let’s turn to some specific recommendations.

How best to preserve your capital

Given no-one, including your author, knows exactly how events will unfold, diversification of your assets should be a key priority. A traditional stock and bond portfolio is fraught with danger given the significant distortions in these markets. Real estate, cash and precious metals should all be considered.

Under different scenarios, you want to protect your capital. If excessive inflation occurs, as happened in the 1970s, then stocks and bonds will get slaughtered. Real estate and gold are better inflation hedges. If there’s mild inflation, stocks will do well, as might gold, while bonds and cash should under-perform. If there’s mild or extreme deflation, bonds and cash should outperform. Gold could also do ok if faith is lost in the paper money system.

For stock exposure, the U.S. looks pricey, while parts of Asia and Europe offer opportunities. In my neighbourhood of Asia, banks in Singapore and Thailand offer reasonable value, beaten down energy and gold socks are worth a look, and inepensive gaming stocks such as Genting Berhad (KLSE:GENT) and Crown Ltd (ASX:CWN) should prove resilient.

For bonds, try to avoid sovereign bonds, barring perhaps prudently run countries such as Singapore. Corporate bonds are worth considering, but remember that these bonds have quasi-equity type qualities. Which means if stocks tank, corporate bonds will suffer too.

For property exposure, residential property in many countries looks elevated. That’s particularly the case in Asia. Office real estate offers better value but is at risk if economies don’t recover. Meanwhile retail property is largely unattractive given the continuing loss of retail market share to the internet. Industrial real estate is probably the most defensive property exposure. Historically this sub-segment has proven less cyclical as significant oversupply is rare given the quick time that it takes to build industrial versus office and retail.

Cash is the world’s most hated asset right now and that’s part of the reason why you should have some in reserve. Central banks want you out of cash and into risk assets, so having some cash is akin to flipping the bird at the Fed. More seriously, you’ll need cash in reserve to take advantage of any opportunities should there be a major shake-out in markets.

Which currencies to own? Ah, that’s the difficult part. The Singapore dollar remains a stand-out. Other than that, there’s not a lot else to like. A basket of Canadian loonie, Thai baht, Malaysian ringgit, U.S. dollar (at least in the short-term), New Zealand dollar and Norwegian krone should be considered.

Now to precious metals. You own gold if you believe there’s even a small chance of a breakdown in the current financial system. It’s disaster insurance. It’s why China is buying as much gold as it can get its hands on. Not because it wants to become the world’s leading currency, as many suggest, but because it doesn’t trust the U.S. dollar or current paper money system (more on that topic at a later date). It foresees the possibility of a new monetary system with the partial or full backing of gold. You might be wise to follow the Chinese when it comes to gold.

This post was originally published at Asia Confidential: http://asiaconf.com/2013/11/09/3-signs-of-bloodbath-ahead/

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/uYzzcHSZAII/story01.htm Asia Confidential

The socialist paradise that is Venezuela has already shown the Federal Reserve just how the world’s greatest “wealth effect” can be achieved courtesy of the Caracas stock market returning over a mindblowing 475% in 2013. Of course, while the US inflation is still slightly delayed (if only for non-core items and those that can’t be purchased on leverage) Venezuela’s own 50%+ increase in annual prices is only part of the tradeoff to this unprecedented “enrichment” of society, or at least 0.001% of it – after all, it’s all about the égalité. More problematic may be the fact that in addition to a pervasive toilet paper shortage, a collapse in the currency, a creeping mothballing of the local energy industry due to nationalization fears, and a virtual halt of international trade as the country’s FX reserves evaporate, Venezuela’s relatively new government had adopted arguably the best and brightest socialist policy wielded by both Hollande and Obama, namely the “fairness doctrine.”

However, in this case it is not about what is a “fair” tax for the wealthy (as taxes in the Venezuela socialist paradise will hardly do much to build up much needed foreign currency reserves), but what is a “fair” price for electronic appliances like flat screen TVs, toasters, and ACs. The result is that Maduro’s government now determines what equilibrium pricing should be.

The reason for this latest socialist victory over the tyranny of supply and demand is that overnight Venezuela’s President Nicolas Maduro ordered the “occupation” of a chain of electronic goods stores in a crackdown on what the socialist government views as price-gouging hobbling the country’s economy. Various managers of the five-store, 500-employee Daka chain have been arrested, and the company will now be forced to sell products at “fair prices,” Maduro said late on Friday.

In essence Maduro is simply going now where Abe soon, and Mr. Chairwoman will go eventually, and in an attempt to offset inflation (at last check Y/Y inflation was over 50%) has effectively “nationalized” prices by forcing retail managers to ignore such trivial things as import prices, and to see well below cost, or at what the government has determined is a “fair” price. Maduro has stopped short of more outright nationalizations, in
this case saying authorities would instead force Daka to sell at
state-fixed prices. Needless to say outright nationalizations are the next step.

That this is the absolute idiocy of any socialist regime in its final, pre-hyperinflation dying throes is well-known to anyone who had the privilege of visiting Eastern Europe just after the collapse of the USSR. However, for the Millennial generation it should serve as a harbinger of things to come to every socialist country that thinks it can rule by central-planning ordain, through a monetary politburo, and is absolutely certain can contain inflation in “15 minutes” or less.

From Reuters:

State media showed soldiers in one Daka shop checking the price tags on large flat-screen TVs. And hundreds of bargain-hunters flocked to Daka stores on Saturday morning to take advantage of the new, cheaper prices.

 

“We’re doing this for the good of the nation,” said Maduro, 50, who accuses wealthy businessmen and right-wing political opponents backed by the United States of waging an economic “war” against him.

 

“I’ve ordered the immediate occupation of this chain to offer its products to the people at fair prices, everything. Let nothing remain in stock … We’re going to comb the whole nation in the next few days. This robbery of the people has to stop.”

 

The measure, which comes after weeks of warnings from the government of a pre-Christmas push against private businesses to keep prices down, recalled the sweeping takeovers during the 14-year rule of Maduro’s predecessor Hugo Chavez.

Venezuela’s people obviously are delighted:

“Inflation’s killing us. I’m not sure if this was the right way, but something had to be done. I think it’s right to make people sell things at fair prices,” said Carlos Rangel, 37, among about 500 people queuing outside a Daka store in Caracas.

 

Rangel had waited overnight, with various relatives, to be at the front of the queue and was hoping to find a cheap TV and air-conditioning unit.

 

Soldiers stood on guard outside the store before it opened.

But how is that possible: is the wealth effect from a 475% YTD return in the Caracas stock market not enough to make everyone perpetually happy and content?

Or did the uberwealth of the 0.001% not trickle down just yet? No worries: it will only take another executive decree to strip the wealthy of their assets, just like it took one order to determine what is “fair pricing” on 50 inch plasma TV, and to enforce “trickle down” economics in this utopia gone bad.

As for what is left of the remaining retail sector, they have gotten the message:

Opponents also blame excessive government controls and persecution of the private sector for shortages of basic goods ranging from flour to toilet paper, and for price distortions and corruption caused by a black-market currency rate nearly 10 times higher the official price.

 

“This ridiculous show they’ve mounted with Daka is a not-very-subtle warning to us all,” said a Venezuelan businessman who imports electronic goods and is an opposition supporter.

 

Under price controls set up a decade ago, the state sells a limited amount of dollars at 6.3 bolivars, but given the short supply, some importers complain they are forced into a black market where the price is nearly ten-fold higher.

 

Maduro showed astonishment at a fridge on sale in Daka for 196,000
bolivars ($31,111 at the official rate), and said an air-conditioning
unit that goes for 7,000 bolivars ($1,111) in state stores was marked up
36,000 bolivars ($5,714) by Daka.

 

“Because they don’t allow me to buy dollars at the official rate of 6.3, I have to buy goods with black market dollars at about 60 bolivars, so how can I be expected to sell things at a loss? Can my children eat with that?” added the businessman, who asked not to be named.

Who expects your children to eat, citizen? After all they didn’t build that negative profit margin. Just eat your peas, be replete of hopium, sell for a “fair price”, be happy you don’t have to sign up for healthcare.ve under gunpoint, and don’t forget to sing the praises of a socialist central-planning utopia. And always remember: BTFATH!

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/O7p8VjxcVRk/story01.htm Tyler Durden

The socialist paradise that is Venezuela has already shown the Federal Reserve just how the world’s greatest “wealth effect” can be achieved courtesy of the Caracas stock market returning over a mindblowing 475% in 2013. Of course, while the US inflation is still slightly delayed (if only for non-core items and those that can’t be purchased on leverage) Venezuela’s own 50%+ increase in annual prices is only part of the tradeoff to this unprecedented “enrichment” of society, or at least 0.001% of it – after all, it’s all about the égalité. More problematic may be the fact that in addition to a pervasive toilet paper shortage, a collapse in the currency, a creeping mothballing of the local energy industry due to nationalization fears, and a virtual halt of international trade as the country’s FX reserves evaporate, Venezuela’s relatively new government had adopted arguably the best and brightest socialist policy wielded by both Hollande and Obama, namely the “fairness doctrine.”

However, in this case it is not about what is a “fair” tax for the wealthy (as taxes in the Venezuela socialist paradise will hardly do much to build up much needed foreign currency reserves), but what is a “fair” price for electronic appliances like flat screen TVs, toasters, and ACs. The result is that Maduro’s government now determines what equilibrium pricing should be.

The reason for this latest socialist victory over the tyranny of supply and demand is that overnight Venezuela’s President Nicolas Maduro ordered the “occupation” of a chain of electronic goods stores in a crackdown on what the socialist government views as price-gouging hobbling the country’s economy. Various managers of the five-store, 500-employee Daka chain have been arrested, and the company will now be forced to sell products at “fair prices,” Maduro said late on Friday.

In essence Maduro is simply going now where Abe soon, and Mr. Chairwoman will go eventually, and in an attempt to offset inflation (at last check Y/Y inflation was over 50%) has effectively “nationalized” prices by forcing retail managers to ignore such trivial things as import prices, and to see well below cost, or at what the government has determined is a “fair” price. Maduro has stopped short of more outright nationalizations, in
this case saying authorities would instead force Daka to sell at
state-fixed prices. Needless to say outright nationalizations are the next step.

That this is the absolute idiocy of any socialist regime in its final, pre-hyperinflation dying throes is well-known to anyone who had the privilege of visiting Eastern Europe just after the collapse of the USSR. However, for the Millennial generation it should serve as a harbinger of things to come to every socialist country that thinks it can rule by central-planning ordain, through a monetary politburo, and is absolutely certain can contain inflation in “15 minutes” or less.

From Reuters:

State media showed soldiers in one Daka shop checking the price tags on large flat-screen TVs. And hundreds of bargain-hunters flocked to Daka stores on Saturday morning to take advantage of the new, cheaper prices.

 

“We’re doing this for the good of the nation,” said Maduro, 50, who accuses wealthy businessmen and right-wing political opponents backed by the United States of waging an economic “war” against him.

 

“I’ve ordered the immediate occupation of this chain to offer its products to the people at fair prices, everything. Let nothing remain in stock … We’re going to comb the whole nation in the next few days. This robbery of the people has to stop.”

 

The measure, which comes after weeks of warnings from the government of a pre-Christmas push against private businesses to keep prices down, recalled the sweeping takeovers during the 14-year rule of Maduro’s predecessor Hugo Chavez.

Venezuela’s people obviously are delighted:

“Inflation’s killing us. I’m not sure if this was the right way, but something had to be done. I think it’s right to make people sell things at fair prices,” said Carlos Rangel, 37, among about 500 people queuing outside a Daka store in Caracas.

 

Rangel had waited overnight, with various relatives, to be at the front of the queue and was hoping to find a cheap TV and air-conditioning unit.

 

Soldiers stood on guard outside the store before it opened.

But how is that possible: is the wealth effect from a 475% YTD return in the Caracas stock market not enough to make everyone perpetually happy and content?

Or did the uberwealth of the 0.001% not trickle down just yet? No worries: it will only take another executive decree to strip the wealthy of their assets, just like it took one order to determine what is “fair pricing” on 50 inch plasma TV, and to enforce “trickle down” economics in this utopia gone bad.

As for what is left of the remaining retail sector, they have gotten the message:

Opponents also blame excessive government controls and persecution of the private sector for shortages of basic goods ranging from flour to toilet paper, and for price distortions and corruption caused by a black-market currency rate nearly 10 times higher the official price.

 

“This ridiculous show they’ve mounted with Daka is a not-very-subtle warning to us all,” said a Venezuelan businessman who imports electronic goods and is an opposition supporter.

 

Under price controls set up a decade ago, the state sells a limited amount of dollars at 6.3 bolivars, but given the short supply, some importers complain they are forced into a black market where the price is nearly ten-fold higher.

 

Maduro showed astonishment at a fridge on sale in Daka for 196,000
bolivars ($31,111 at the official rate), and said an air-conditioning
unit that goes for 7,000 bolivars ($1,111) in state stores was marked up
36,000 bolivars ($5,714) by Daka.

 

“Because they don’t allow me to buy dollars at the official rate of 6.3, I have to buy goods with black market dollars at about 60 bolivars, so how can I be expected to sell things at a loss? Can my children eat with that?” added the businessman, who asked not to be named.

Who expects your children to eat, citizen? After all they didn’t build that negative profit margin. Just eat your peas, be replete of hopium, sell for a “fair price”, be happy you don’t have to sign up for healthcare.ve under gunpoint, and don’t forget to sing the praises of a socialist central-planning utopia. And always remember: BTFATH!

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/O7p8VjxcVRk/story01.htm Tyler Durden

 

I was blown out by the Labor Force Participation Rate (LFPR) data released Friday. Down 4 tics to 62.8%. That sounds like no big deal, but it is. Either there is something out of whack with the data, and it will be revised, or there will have to be some serious rethinking by the folks who develop long-term economic models, and also at the Federal Reserve.

Consider the short term consequences. The Fed has hung its monetary hat on an unemployment rate of 6.5%. We have been told, time and again, that if the magic number of 6.5% unemployment is reached, the madness of US monetary policy will be relaxed. Should the LFPR continue to drop, the hurdle rate for changes to Fed policy will come sooner than is anticipated.

The Atlanta Fed has an interactive tool that looks at this (Link). It takes into consideration the variables of the unemployment picture and produces a report of how many jobs are needed per month over a given period, to achieve the 6.5% level. A few examples:

 

As you can see, the Fed's target can be reached in the next 12 months if the LFPR falls a bit further. I'm quite certain that should things unfold like this the new head of the Fed, Janet Yellen, will change the 'rules' and ignore the 6.5% target and continue along with ZIRP and QE. But if she does that, it will be at her (and our) risk.

 

Then you have the long-term side of declining LFPR. A low LFPR means that there are less workers earning taxable income. That translates into less government revenue. Payroll taxes (Social Security and Medicare) total 15% of wages. For an average worker making $40,000 a year that comes to $6,000. When the LFPR drops by 0.1% it means that there will be 180,000 less workers filling the tax bucket. The .1% drop translates into $1Bn less in tax revenue. The .4% drop in October therefore means $4Bn in lost revenue. It adds up quick.

All of the models used to forecast future federal deficits rely on a much higher LFPR assumption than today's reality. The Congressional Budget Office did a long term forecast of LFPR. The CBO hung its hat on a LFPR that is higher than 62.8%, meaning the forecasts of future tax receipts (and subsequent deficits) were wrong.

 

 

The 64.4% assumption the CBO used versus the 62.8% that exists today translates into 4m less workers contributing to the system, and those 4m workers (and their employers) will not pay $25B in payroll taxes. A 1/4 trillion adjustment over ten-years just due to a revision of the LFPR. That's real money.

I've looked at long-term forecasts for LFPR from CBO and BLS. They all have the participation rate dropping over time, but they do not have the drop occurring in the present. What if the 'New Normal' is a participation rate that hangs in the low 60% level for the next decade? It translates into much larger deficits at the Federal and State levels. It means that there will be less consumption as there will be fewer paychecks, and that means a much lower rate of growth of GDP.

So either the LFPR turns around and starts headed higher very soon (and stays higher for another decade), or the USA is in for a prolonged period of sub par growth and very high annual deficits.

Consider this chart of LFPR. The drop is accelerating. What are the odds that the long-term trend towards lower participation is going to turn around soon? I would say, "Not high".

 

Note: This analysis only looks at the consequences to payroll taxes from a drop in LFPR. There is is also lost revenue from State and Federal income taxes, and there is the broader drop in consumption to add into the mix. All in, the drop in participation is a very big deal.

 

 

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Y_jJiizOnug/story01.htm Bruce Krasting

Submitted by F.F. Wiley of Cyniconomics

M.C. Escher And The Impossibility Of The Establishment Economic View

It’s easy to show that public institutions such as the Federal Reserve and Congressional Budget Office (CBO) are routinely blindsided by economic developments. You only need to compare their past predictions to real events to see these organizations’ deficiencies.

More importantly, we can demonstrate that their struggles are all but certain to continue. This may sound like a difficult task, but we’ll argue that it’s easier than you think. Using historical data and basic economic concepts, we’ll explain not only why the establishment view is wrong but that the underlying principles are fundamentally flawed. The implication is that existing policies are destined to fail.

To make our case, we’ll start with the CBO’s current forecasts for real per capita GDP (economic growth net of inflation and population growth):

Our regular readers already know that the CBO is abnormally bullish on near-term growth, based on its long-standing assumption that the gap between actual and potential output will swiftly close. But this won’t be our focus here. In fact, we’ll assume the CBO gets this part of its outlook right. We’ll be shocked if it does, but let’s pretend.

We’ll then examine the forecasted path for interest rates:

The interest rate outlook is an offshoot of the policy establishment’s overall approach. Monetary stimulus is expected to be removed as it guides the labor market toward full employment, allowing interest rates to return to normal levels.  At that point, natural economic forces are believed to be strong enough to preserve a normal, healthy economy. Establishment economists have near complete faith that this is a sound and reliable process.

But closer examination reveals a few cracks. Consider that the chart above shows quite a jump in interest rates, which begs the question: How will the economy weather such a development?

We’ll look to history for possible answers. We calculated the change in rates on three month Treasury bills for every eight quarter period since 1953, which breaks down like this:

We then reviewed past economic outcomes conditioned on the rate buckets above. Note that the forecasted 2015 to 2017 rate change of 3.2% (the leap from 0.2% to 3.4% in Chart 2) falls in the final bucket. Therefore, this bucket is especially relevant to the economy’s likely performance in the next rate cycle. We circled it in the charts below:

While the results speak for themselves, I’d be remiss if I didn’t add qualifiers. For one, the sample sizes fall as you move from left to right across the charts. Moreover, history doesn’t always foretell the future; this time could be different.

But the thing is: the data makes perfect sense. Higher interest rates have obvious effects on risk taking and debt service costs. It stands to reason that the economy won’t just sail through the large rate hikes needed to restore historic norms.

If anything, the charts likely understate the future effects of rising rates, because today’s debt levels are far higher than average historic levels. Any normalization must also include a wind-down of unconventional measures such as quantitative easing, which presents additional challenges.

Yet, the official outlook calls for steady improvement both through and beyond the rate jump. As shown in Chart 1, the CBO predicts that per capita GDP growth will accelerate to over 3% before settling back to a trend rate of 1.2%.  Forecasts for 2018 and 2019 average a healthy 1.5%, despite the figures in Chart 5 showing virtually no growth after large interest rate increases in the past.

Here’s the corresponding outlook for employment, followed by two more reasons to expect forecasts to fail:

 

(See here for background on the corporate leverage multiples and here for more on the stock valuation figures.)

In a word, the CBO’s projections are preposterous. They ignore effects that are clear in the data and obvious in real life. But the charts reveal more than just forecasting flaws at a single governmental institution. More broadly, the assumption of a smooth and lasting return to normality is standard practice for mainstream economists, particularly those at the Fed.

Essentially, economists are hardwired to focus on the near-term effects of policy stimulus, while dismissing long-term effects that are often far more important. Standard models fail to account for either natural cyclicality or the payback seen in Charts 4 to 6. Although establishment economists often speak about sustainable growth, they really mean any growth that restores GDP to where they believe it should be. They don’t seriously contemplate the unsustainable growth that occurs when the economy is over-stimulated through credit and financial asset channels. And the charts above demonstrate these deficiencies.

Worse still, this analysis doesn’t tell the whole story. We could have easily tripled the chart sequence with other indicators of Fed-fueled credit and asset market froth – from record margin debt to lax loan covenants to soaring public debt – that also show heightened risks of another bust.

We suggest giving some thought to the data shown abo
ve and considering its message for the future. Send it to the smartest people you know and get their opinions. In the meantime, here are our conclusions:

1: Even if the economy returns to full employment under existing policies, it won’t remain there after (and if) interest rates normalize.

2: Based on today’s debt and valuation levels (charts 8-9, for example), rising interest rates will have an even harsher effect than suggested by the 60 year history (charts 4-6).

3: Contrary to the establishment’s “sustainable recovery” narrative, the most plausible outcomes are: 1) interest rates normalize but this triggers another bust, or 2) interest rates remain abnormally low until we eventually experience the mother of all debt/currency crises.

Conclusion 3 restated: We’re stuck in an Escher economy (see below), thanks to the impossibility of the establishment economic view, and this will remain the case until the existing structure collapses and is rebuilt on stronger policy principles.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/xljTsgugtG0/story01.htm Tyler Durden

Submitted by F.F. Wiley of Cyniconomics

M.C. Escher And The Impossibility Of The Establishment Economic View

It’s easy to show that public institutions such as the Federal Reserve and Congressional Budget Office (CBO) are routinely blindsided by economic developments. You only need to compare their past predictions to real events to see these organizations’ deficiencies.

More importantly, we can demonstrate that their struggles are all but certain to continue. This may sound like a difficult task, but we’ll argue that it’s easier than you think. Using historical data and basic economic concepts, we’ll explain not only why the establishment view is wrong but that the underlying principles are fundamentally flawed. The implication is that existing policies are destined to fail.

To make our case, we’ll start with the CBO’s current forecasts for real per capita GDP (economic growth net of inflation and population growth):

Our regular readers already know that the CBO is abnormally bullish on near-term growth, based on its long-standing assumption that the gap between actual and potential output will swiftly close. But this won’t be our focus here. In fact, we’ll assume the CBO gets this part of its outlook right. We’ll be shocked if it does, but let’s pretend.

We’ll then examine the forecasted path for interest rates:

The interest rate outlook is an offshoot of the policy establishment’s overall approach. Monetary stimulus is expected to be removed as it guides the labor market toward full employment, allowing interest rates to return to normal levels.  At that point, natural economic forces are believed to be strong enough to preserve a normal, healthy economy. Establishment economists have near complete faith that this is a sound and reliable process.

But closer examination reveals a few cracks. Consider that the chart above shows quite a jump in interest rates, which begs the question: How will the economy weather such a development?

We’ll look to history for possible answers. We calculated the change in rates on three month Treasury bills for every eight quarter period since 1953, which breaks down like this:

We then reviewed past economic outcomes conditioned on the rate buckets above. Note that the forecasted 2015 to 2017 rate change of 3.2% (the leap from 0.2% to 3.4% in Chart 2) falls in the final bucket. Therefore, this bucket is especially relevant to the economy’s likely performance in the next rate cycle. We circled it in the charts below:

While the results speak for themselves, I’d be remiss if I didn’t add qualifiers. For one, the sample sizes fall as you move from left to right across the charts. Moreover, history doesn’t always foretell the future; this time could be different.

But the thing is: the data makes perfect sense. Higher interest rates have obvious effects on risk taking and debt service costs. It stands to reason that the economy won’t just sail through the large rate hikes needed to restore historic norms.

If anything, the charts likely understate the future effects of rising rates, because today’s debt levels are far higher than average historic levels. Any normalization must also include a wind-down of unconventional measures such as quantitative easing, which presents additional challenges.

Yet, the official outlook calls for steady improvement both through and beyond the rate jump. As shown in Chart 1, the CBO predicts that per capita GDP growth will accelerate to over 3% before settling back to a trend rate of 1.2%.  Forecasts for 2018 and 2019 average a healthy 1.5%, despite the figures in Chart 5 showing virtually no growth after large interest rate increases in the past.

Here’s the corresponding outlook for employment, followed by two more reasons to expect forecasts to fail:

 

(See here for background on the corporate leverage multiples and here for more on the stock valuation figures.)

In a word, the CBO’s projections are preposterous. They ignore effects that are clear in the data and obvious in real life. But the charts reveal more than just forecasting flaws at a single governmental institution. More broadly, the assumption of a smooth and lasting return to normality is standard practice for mainstream economists, particularly those at the Fed.

Essentially, economists are hardwired to focus on the near-term effects of policy stimulus, while dismissing long-term effects that are often far more important. Standard models fail to account for either natural cyclicality or the payback seen in Charts 4 to 6. Although establishment economists often speak about sustainable growth, they really mean any growth that restores GDP to where they believe it should be. They don’t seriously contemplate the unsustainable growth that occurs when the economy is over-stimulated through credit and financial asset channels. And the charts above demonstrate these deficiencies.

Worse still, this analysis doesn’t tell the whole story. We could have easily tripled the chart sequence with other indicators of Fed-fueled credit and asset market froth – from record margin debt to lax loan covenants to soaring public debt – that also show heightened risks of another bust.

We suggest giving some thought to the data shown above and considering its message for the future. Send it to the smartest people you know and get their opinions. In the meantime, here are our conclusions:

1: Even if the economy returns to full employment under existing policies, it won’t remain there after (and if) interest rates normalize.

2: Based on today’s debt and valuation levels (charts 8-9, for example), rising interest rates will have an even harsher effect than suggested by the 60 year history (charts 4-6).

3: Contrary to the establishment’s “sustainable recovery” narrative, the most plausible outcomes are: 1) interest rates normalize but this triggers another bust, or 2) interest rates remain abnormally low until we eventually experience the mother of all debt/currency crises.

Conclusion 3 restated: We’re stuck in an Escher economy (see below), thanks to the impossibility of the establishment economic view, and this will remain the case until the existing structure collapses and is rebuilt on stronger policy principles.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/xljTsgugtG0/story01.htm Tyler Durden

With the help of the unexpected ECB rate cut and better than expected US economic data, the US dollar showed the kind of strength the technical reading suggested was likely last week.  However, the market appears to have run ahead of itself and the immediate risk is for a setback in the dollar.

 

The fundamental drivers may have been exaggerated.  The ECB’s refi rate cut is largely symbolic in nature as the interbank rate trades closer to the zero deposit rate and is largely unchanged from where it was prior to the ECB’s surprise move.  The implied yield of the December 2014 Euribor futures contract was three basis points lower on the week.  

 

Similarly, the 14 bp jump in the US 10-year Treasury yield in response to the stronger than expected establishment survey exaggerates the likelihood of the introduction of tapering at the December FOMC meeting.   What looks like improvement is really noise around a signal of steady but gradual improvement in the labor market.  The 3-month average of private sector payroll growth is just below 190k.  The 6-month average is 175k, while the 12-month average stands at 196k.  

 

Moreover, price pressures, as shown by the core PCE deflator of 1.2%, are still threatening deflation and was recognized as such by none other than Bernanke himself, when he was a Governor on the Federal Reserve in the early 2000s.   Without inflation moving back toward the Fed’s target, there is no urgency to taper.  

 

Euro:  Convincingly violated the July-September up trend line and the 5-day moving average has crossed below the 20-day average.  The US jobs data failed to drive the euro below the ECB-spurred lows, which correspond to a (50%) retracement of the rally since July (~$1.3290).  The euro traded below its 100-day moving for the first time in two months, though was unable to close the North American session below there.  The euro is also flirting with the lower of its Bollinger Bands set at two standard deviations below the 20-day moving average.    Technical indicators allow scope for further euro losses, but they may prove limited before a bounce.  Resistance is now seen in the $1.3450-80 area.  

 

Yen:   Remains well within a consolidative range that has been carved out over the past six-months. The US Treasury premium (10-year) over JGBs has widened by about 25 bp over the past week or so to reach a new two-month high above 215 bp.  At the same time, the Nikkei appears to have found support near 14000.  While these developments should underpin the greenback and the technical readings are constructive,  it is not clear that the upside has much to offer.   The dollar has not enjoyed two consecutive closes above JPY100 in four-months.  

 

Sterling:  Appears to be continuing to carve out a top of some importance.  Sterling spent last week within the range established the previous week and the upticks were capped be a (61.8%) retracement objective of the pullback since recording what we suspect is the second of a double top near $1.6260. The neckline, seen near $1.5900 contained sterling downticks at the start of the week and the soft close ahead of the weekend warns of a potential retest.  However, like we suggested with the euro, those downticks are likely to be short-lived.  

 

Swiss franc:  Shed a little more than 4% against the US dollar since October 24.  The greenback is trading at two-month highs against the franc.  It was kept in check at the end of last week by the (38.2%) retracement of the slide since May (~CHF0.9250) and coincides with the 100-day moving average.   While we anticipate additional gains (~CHF0.9350-CHF0.9475), we are more inclined to buy dollar pullbacks than chase this rally.  

 

Canadian dollar: Slipped to its lowest level in two-months before the weekend.  The US dollar hit down trend line drawn off the mid-July, late-August and early-September highs a little above CAD1.05.   Technical indicators and the cross-over of the 5- and 20-day averages are constructive.  A move above the trend line would target CAD1.0560 initially, with stiffer resistance near CAD1.06.   Support is seen ahead of CAD1.04.  

 

Australian dollar:  Encouraged by a dovish monetary policy statement by the Reserve Bank of Australia, the Aussie was pushed convincingly below $0.9400 for the first time in a month.  The down draft halted near the (50%) retracement of the advance off the August 30 low, which was found near $0.9325.   Scope for corrective upticks extends toward $0.9400-25.   The New Zealand dollar is particularly interesting from a technical perspective.  The US dollar has carved out a potential head and shoulders pattern.  A convincing break of the  $0.8200 neckline would suggest potential toward $0.7850.

 

Mexican peso:  After approaching the Oct high near MXN13.3450, the dollar revered course before the weekend.   However, the pullback failed to violate the greenback’s uptrend.  Support is seen around MXN13.10 and the upper end of the multi-month trading range is near MXN13.45.  

 

 

Observations of speculative positioning in the CME currency futures:  

 

1.  There were two significant position adjustments.  The gross long euro positions were slashed by 32.7k contracts.  Gross short yen positions grew by 12.6k contracts.    Ten of the remaining 12 gross positions we monitor were changed by less than 5k contracts.  

 

2.  All the currency futures, but the Australian dollar, saw gross short positions increase.  The gross short Australian dollar position was reduced by less than 1k contracts.    Gross long currency futures positions were mostly trimmed, with the exception of  yen and Mexican peso.  

 

3.  The modest decrease in gross long sterling positions and a modest increase in gross shorts was sufficient to swing the net position back in favor of the shorts for the first time since late September.  

 

4.  The Commitment of Traders report shows that speculators were reducing their short dollar position ahead of the ECB meeting, where a surprise rate cut was delivered, and stronger than expected US jobs data.  It ought not be surprising to see these trends continue into the next CFTC report.

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Submitted by Michael Krieger of Liberty Blitzkrieg blog,

America has become a gigantic gulag over the past few decades and most of its citizens don’t know, or just don’t care. One of the primary causes of the over incarceration in the U.S. is the absurd, tragic failure that is the “war on drugs”, and indeed nearly half of the folks in prison are there for drug related offenses. Making matters worse is a rapidly growing private prison system, which adds a profit motive to the equation. Recently, I wrote an extensive rant against the private prison system and provided details on how it works in:  A Deep Look into the Shady World of the Private Prison Industry.

Now here are some of the sad facts. There are 1.57 million people in federal and state prison (does not even include county and local jail) according to the Department of Justice. That’s above the nation’s 1.53 million engineers and 1.05 million high school teachers.

 

More from the Huffington Post:

If sitting in a prison cell was a job, it would be one of the most common jobs in the United States. In 2012, there were some1,570,000 inmates in state and federal prisons in the U.S., according to data from the Justice Department.

 

By contrast, there were about 1,530,000 engineers in America last year, 815,000 construction workers, and 1 million high school teachers, according to the Bureau of Labor Statistics.

 

There were also 750,000 car technicians.

Yep, you know it. USA! USA!

Full article here.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/wmwjYqSIJ4Y/story01.htm Tyler Durden

We previously highlighted Didier Sornette’s excellent work trying to identify pre-crash conditions in financial markets and John Hussman’s chart below suggests we are indeed heading that way. His warning, however, “Don’t rely on further blow-off – but don’t be shocked – risk dominates… Hold Tight.“

 

 

Via @Hussmanjp

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Submitted by Peter Schiff of Euro Pacific Capital,

Most market watchers expect that Janet Yellen will grapple with two major tasks once she takes the helm at the Federal Reserve in 2014: deciding on the appropriate timing and intensity of the Fed’s quantitative easing taper strategy, and unwinding the Fed’s enormous $4 trillion balance sheet (without creating huge losses in the value of its portfolio). In reality both assignments are far more difficult than just about anyone understands or admits.
 
Unlike just about every other economist, I knew that the Fed would not taper in September because the economy is still fundamentally addicted to stimulus. The signs of recovery that have caused investors and politicians to bubble with enthusiasm are just QE in disguise. Take away the QE and the economy would likely tilt back into an even more severe recession than the one we experienced before QE1 was launched.
 
Given the Fed’s failure to initiate a tapering campaign in recent months (when it was highly expected) it is surprising that most people still believe that it will pull the trigger in the first quarter of 2014. But if the Fed could not take action in September, with Ben Bernanke at the helm and the nation as yet untraumatized by the debt ceiling drama and Obamacare, why should we expect tougher treatment from Janet Yellen? This is particularly true when you consider Yellen’s reputation as an extreme dove and the uninspiring economic data that has come in recent months. 
 
Rather than explicitly describing the possibility of a reduction of asset purchases, recent Fed statements have merely said that policy would be “adjusted” according to incoming data. It has never said what direction that adjustment may take. Yet somehow the market has concluded that an imminent reduction is the only possibility. But the opposite conclusion is more likely. Recession avoidance is really the Fed’s only concern and it will always come down on the side of accommodation. Therefore an expectation for a 2014 taper is just wishful thinking.
 
But that does not mean that QE will go on forever. It will come to an end, but not because the Fed wants it to, but because the currency markets give it no choice. A dollar crisis would ultimately force the Fed’s hand, and the longer the Fed succeeds in postponing the inevitable, the more damage its policy mistakes will inflict on our economy.
 
Yellen’s second task will be equally impossible. Since the QE campaign began in 2010 the Fed has more than quadrupled the amount of bonds that it holds on its balance sheet,to more than $4 trillion of Treasury and mortgage-backed bonds. To accumulate this massive cache, the Fed has become by far the largest buyer in both markets. Its purchases have pushed up the prices of those bonds and have kept long term interest rates low for both consumers and businesses.
 
When the QE was first launched, Ben Bernanke tamped down fears of the program by saying the Fed would one day sell the bonds that it was buying. But as the Fed’s balance sheet ballooned, many in the market began fearing that the unwinding of these trades would crush the market for Treasuries and mortgage-backed securities. Bernanke soon allayed these fears by saying that the Fed would not actively sell, but would simply allow bonds to mature. But this is just a convenient fiction.
 
If stock or real estate prices were to enter into bubble territory (which I believe has already happened), or if inflation were ever to surge past the Fed’s low target range (which I believe is certain to happen), then the Fed would have to sell bonds to get in front of these trends.
 
Through Operation Twist, the Fed has already swapped a very large portion of its short-term bonds for long-term bonds. The slow process of waiting for bonds to mature is unlikely to slow down asset bubbles or inflation. The argument also does not account for the fact that the Treasury will have to sell new bonds in order to retire the principle on the maturing bonds. Since the Fed is the primary buyer of Treasury bonds, the Fed would have to add to its balance sheet when it’s trying to shrink it. Such a cycle is just a debt rollover that leaves the size of the Fed’s balance sheet unchanged.
 
Unless other buyers of Treasuries or MBS can be found to replace the Fed’s prodigious buying, the Fed will remain the only game in town. Given these realities, how can we possibly expect Janet Yellen to actually diminish the amount of assets the Fed holds? She won’t be able to do it and any expectations to the contrary are pure fantasy.
 
So we should not be asking when Ms. Yellen will begin withdrawing stimulus and shrinking the Fed’s balance sheet. Instead we should be asking how the markets will react when she runs out of excuses for delaying the taper, or ultimately decides to expand QE rather than contract it.

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