RACE TO DEBASE : The "Race to Debase" Accelerates in a "Race to the Bottom"
The November GMTP issue discusses the Regional Macro Economic Issues in Europe, Japan, China and the Emerging Economcis and BRICS countries. The IMF, World Bank and BIS have all warned of heightened economic and financial risk. The IMF cut the grwoth rate of the advanced economies by 25% taken it down to levels not seen since 2009. The World Bank released a study indicating theat 600 million new jobs must be created over the next 15 years to meet economic and social demands. Meanwhile global growth is falling at rates not seen since the early stages of the 2008 financial crisis.
Currency Wars have entered a new stage has global economies fight for a shrinking piece of export/import demand. Any Geo-Politicl event, an unresolved US Fiscal cliff or unexpected corporate financial failure could be the catalyst to push the world into its first global recession.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY
THE P/E COMPRESSION GAME: An Old Game with a Different Twist to Misprice Risk
We are manipulating markets metrics in such a fashion as to intentionally Misprice, Misrepresent & Hide RISK. Prior PE reference boundary conditions which reflected risk have decoupled. Never has the game of forward operating earnings (versus historically trailing earnings) been more inappropriate than presently. Forward PE's can only be of value in rapid revenue and profit growth eras. This is not what we have presently. It is the wrong tool for the wrong job! Unless you are a sell side analyst, then it is exactly the right too for the difficult selling job you have. We have an era of Peak earnings growth RATES, slowing profit growth RATES and Peak PEs which are reflective of rapidly contracting PE's. We have a secular bear market in REAL terms but PE's are not contracting at a sufficient enough rate to reflect this. Though PEs in nominal terms net out inflation, they don't reflect the underlying downward trend in real terms. MORE>>
We have witnessed QEfinity "Unlimited", OMT "Uncapped', and the US Election results. Now we begin to watch the Fiscal Cliff political poker game unfold. So far it has been a Buy on the Rumor, Sell on the News scenario with markets down significantly since each event, but appearing to find support at the 200 DMA. With US government facing another downgrades to its "Risk Free" status, earnings plummeting and a clear global slowdown in progress, what should we expect before year end and more importantly in the New Year? The short answer is 'volatility' as we complete the "Right Shoulder" of a classic Head and Shoulders pattern of a major Long Term Technical structure. Once complete we then head lower.
A Santa Claus Rally is highly likely despite a rarely confirmed Hindenberg Omen and technical chart patterns that mirror the pre-1987 market crash - way too closely for this analyst. The markets are at levels of extreme risk which is not priced in. Most investors are best advised to stand aside and error on being too conservative. It is too risky at this moment to be either net long or short. Soon however there will be a lower risk entry to be net short the market for the 2013 market clearing event, which the macro charts are consistently signaling.
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Hopes for an early recovery in the global economy may be overoptimistic, according to CLSA's Russel Napier, as he notes the expansion of China's reserves, which has been an engine of global economic growth, is about to come to a shuddering halt. As eFinancial News notes, Chinese reserves have decelerated dramatically over the last five years and are now close to zero. Napier said of the graph: "It is the most important chart in the world. The growth in Chinese reserves has determined all the key developments in financial markets in the last two decades. It printed lots of currency and artificially depressed the US yield curve. It has been the cornerstone of global growth, and now it's over."
The last time the Chinese reserve growth rate was below 10% was at the end of the 1990s, just before the bursting of the technology stock market bubble and a recession. The recovery in the growth rate from 2001 onwards was followed by the economic boom of the last decade. The growth rate turned down decisively in 2007, just before the onset of the financial crisis.
China's reserves have come from a trading surplus, and the Chinese authorities have used the money to buy US Treasury bonds. The finance that China supplied to the US helped fuel economic growth in that country and the rest of the world.
Once again, we are reminded that it is the flow not the stock that counts for 'growth' is credit expansion and credit is growth...
Despite the hope of the last day or two, policymakers remain, we suggest, as far apart as they ever have, with 'no news' simply that. An oversold bounce does not a fiscal cliff fix, and as BofAML's Michael Hanson suggests in his 'brief history of brinksmanship': "one lesson from the recent past is that market reaction has been an important mechanism to reaching compromise and forcing action." Unfortunately, he adds, as we have been quite vociferous about, that "history also shows that the equity markets have to sell off sharply before policy makers listen to the 'stock market vigilantes'." With some politicians still thinking going over the cliff might be their best strategy, it could once again take a sharp market sell-off to focus the minds of the negotiating parties. If we actually manage to go over the cliff, even if only for a brief period of time, a repeat of the TARP sell-off seems only too probable.
Via BofAML: A brief history of brinkmanship by Michael S. Hanson
Policymakers have recently made a habit of creating deadlines, thresholds and cliffs to force themselves to act. The result has often been severe market volatility around key decision dates. Markets may be in for yet another bumpy ride as US fiscal cliff and European sovereign debt negotiations continue. However, one lesson from the recent past is that market reaction has been an important mechanism to reaching compromise and forcing action. Unfortunately, history also shows that the equity markets have to sell off sharply before policy makers listen to the “stock market vigilantes.”
The fiscal cliff is the latest example of a brinkmanship moment — and a large one to boot. Japan just recently averted its own fiscal cliff scenario, and several budgetary challenges loom for peripheral European countries. Politicians appear to have learned from past episodes that these deadlines are useful negotiating tools. But a review of recent history suggests it is less the deadlines themselves than the negative market reaction as the deadline approaches — or goes whistling past without action — that actually forces some resolution.
Toss a damp TARP on it
The debate over TARP (the Troubled Asset Relief Program) is perhaps the canonical example of a brinkmanship moment where the market forced action. Treasury Secretary Henry Paulson formally proposed the TARP on 21 September 2008, and the markets started to rally a few days earlier on the news of the bailout plan. A contentious battle with Congress followed, as the Senate Banking Committee rejected the plan on 23 September. The House and Senate then worked to fasten a compromise, but that was rejected by the House on 29 September by a 205-228 vote, largely along party lines. The S&P 500 fell 8.8% on that day alone. TARP was finally passed after the third try on 3 October, but the damage was done. Markets continued to drop sharply over the next week, ultimately dropping more than 28% from when the news of TARP first leaked out. Equity markets sold off sharply in Asia and Europe as well.
Rolling European risks
Similarly, the sovereign and banking crises in Europe have resulted in a number of market sell-offs and spikes in volatility (Chart 1). In May 2010, market volatility again mounted as uncertainty preceded the adoption of the first bailout plan for Greece — the first of several. Additional market sell-offs occurred around other European policy debates, including setting up support programs for other peripheral countries and the establishment of the EFSF and ESM. Despite various actions by the ECB that soothed the markets (rate cuts, LTROs, OTM), the risk of additional brinkmanship in 2013 remains, as northern bailout fatigue meets up against southern reform resistance.
The debt limit debacle
TARP was the first scene in the multi-act tragedy that has been US fiscal policy over the past several years. Passing “continuing resolutions” at the last minute that avert a government shutdown, but only keep the federal government running temporarily has become the norm. In mid-2011, US politicians went to the brink over the debt limit, as conservative House Republicans toyed with the possibility of a default on US Treasury debt to get President Obama and Senate Democrats to accede to significant spending cuts. Again, the markets sold off sharply, helping cement the Budget Control Act of 2011. This act included the now infamous “Supercommittee,” charged with agreeing to a comprehensive, long-term deficit reduction plan. Instead, they agreed to disagree and fell into another threat point that was never meant to happen: the US$1.2tn automatic spending cuts known as the sequester. The markets again sold off in late November 2011 on that news. Other measures of uncertainty spiked as well (Chart 2), and have generally remained high.
Clambering along the US fiscal cliff
In all of these cases the market reaction — or threat thereof — helped to motivate policy makers to step back from the brink and find a solution. The same is likely the case, in our view, for the ongoing fiscal cliff negotiations — itself a construct of delays and manufactured deadlines. Once it became clear that the US election would largely return the status quo to power — the same folks who built the cliff — the markets sold off as they reassessed the risks around the cliff (Chart 3).
This past Friday, a meeting at the White House to start the cliff negotiations concluded cordially, pushing up market optimism. However, no policy decisions were reached, and news reports suggested that the two sides largely agreed to disagree for now on several key points, such as how to raise additional revenue as part of any deal. There is limited time to put together anything more than a down-payment on a bigger deal that will have to be negotiated further — and likely will have its own deadlines and triggers should an agreement remain out of reach.
Meanwhile, the recent market reaction demonstrates the risk of additional volatility as investors grow optimistic when “good news” on the cliff is announced. When talks stumble at a difficult stage of the negotiations, which seems inevitable given the distance that remains between the two sides, markets may again sell off. Moreover, every time the market reacts positively to even the lightest of positive news, the pressure on policy makers to reach a conclusion relaxes. With some politicians still thinking going over the cliff might be their best strategy, it could once again take a sharp market sell-off to focus the minds of the negotiating parties. If we actually manage to go over the cliff, even if only for a brief period of time, a repeat of the TARP sell-off seems only too probable.
Even if both the Bush tax cuts and emergency unemployment insurance are extended, the 'sequester' is mostly postponed, and the fresh fiscal drag is confined to the expiration of the payroll tax cut and the new taxes to pay for Obamacare, Goldman estimates suggest that fiscal policy would shave nearly 1.5% from real GDP growth in early 2013. While it seems the 'market' believes that some compromise will be enough to lift the market to new stratospheric heights; we believe, as does Goldman, that the risks are almost exclusively on the downside of this 'not so good' fiscal scenario.
Via Goldman Sachs:
We forecast a renewed slowdown in growth to 1½% in Q1, despite the healing in the private sector and renewed monetary easing.
In addition, the risks are almost exclusively on the downside of this “not so good” fiscal scenario. The probability that the upper-income Bush tax cuts and emergency unemployment legislation will expire, as well as that of a temporary hit from the entire cliff, has clearly risen in recent months. Adding these sources of restraint would take the overall fiscal drag to nearly 2 percentage points in early 2013, and more if the uncertainty effects are large. A sharper slowdown in GDP growth to 1% or less would likely result.
The tail risk is that Congress will fail to agree on any type of resolution for a more extended period, and the economy is hit with both the sequester and much bigger tax increases. While the impact of such a failure—especially those related to confidence and financial conditions—is harder to quantify, just the direct fiscal effect would imply a GDP growth hit of around 4 percentage points in early 2013, and likely a recession.
The Not So Good: Our Base Case
Our base case is that the fiscal cliff is (just barely) resolved by year end, most likely with a temporary extension of the 2001 and 2003 tax cuts, a continued phase down of Emergency Unemployment Compensation (EUC) and a temporary delay of the spending cuts under sequestration. Under our central assumption we assume that the $120bn payroll tax cut expires at year end and that new taxes that were enacted as part of the Affordable Care Act (ACA) are implemented on schedule.
The Bad: A Temporary Lapse; Upper Income Tax Cuts and Jobless Benefits Also Expire
A second possible scenario is that lawmakers will allow the upper income portions of the 2001/2003 tax cuts (defined as income over $250,000) and EUC to expire, in addition to the fiscal restraint in our base case. While it is possible that Congress could vote prior to year end to “decouple” the upper income tax cuts from the rest of the Bush tax cuts, it is more likely in our view that this would happen after year end due to fundamental disagreement between the political parties.
The White House has indicated on several occasions that the President would veto a further extension of the upper-income provisions, while Congressional Republicans have indicated they would not support decoupling them from the rest of the 2001/2003 tax cuts.
While there are possible compromises between these two positions—raising rates only on income over $1 million, for instance—reaching an agreement on this in the few weeks lawmakers will have before year end seems to us to be a significant political challenge. A deal on this question could also be made easier once taxes have risen, since lawmakers could claim that setting tax rates and/or revenue levels higher than 2012 would nevertheless constitute a “tax cut” compared with the policies that would be in effect in January 2013.
We assume that if the upper income tax cuts are allowed to expire, emergency jobless benefits would expire as well. In light of the continued phase down in eligibility since the start of the year, the expiration would not have as great of an effect as it would have had a couple of years ago, but would still represent an incremental drag on growth compared with our base case.
Such a scenario would likely result in growth below our forecast for 2013, particularly in the first half of the year, especially if some of the 2001/2003 tax cuts and EUC were allowed to expire. That said, there are at least three reasons to think that while negative, a temporary lapse would not hit growth by nearly as much as implied in the worst-case scenario:
A lapse would probably be reversed quickly. It is likely that if Congress were to fail to address this issue before the end of the year, lawmakers would return inJanuary and reach an agreement fairly quickly. The debt limit, which Congress must raise no later than early March according to our projections, might serve as a deadline for action on the fiscal cliff if public pressure hasn’t already forced an agreement. If, for example, an agreement were reached in January, we assume it would reinstate most policies retroactively, meaning that much of the effect would be reversed before the end of the quarter, reducing the overall economic effect.
The Administration may have some flexibility in implementing tax hikes and spending cuts. Beyond the likelihood that Congress would revisit the fiscal cliff fairly quickly if these provisions were to expire, there is a possibility that the Treasury and other federal agencies could delay implementation of the scheduled fiscal tightening if the lapse was expected to be temporary. On the tax side, the Treasury may have some flexibility in determining tax withholding. It is possible that if Congress were expected to extend the tax cuts retroactively, the Treasury could maintain tax withholding at current levels in anticipation of an agreement. This would cushion the effect of a short lapse, but would be ineffective in addressing a prolonged lapse in the 2001/2003 tax cuts. It is possible that the phase-in of the sequester could also be made more gradual if the cuts were expected to be reversed early in 2013.
Uncertainty effects would depend on why a lapse occurs. It is difficult to assess how consumers or businesses would react in the face of a temporary tax increase. If a retroactive extension of most or all of the policies is widely expected, it is quite possible that some consumers would “look through” a temporary reduction in after-tax income. That said, we suspect that if Congress fails to address the fiscal cliff at year-end it will be due to a political stalemate, so there could be at least short-term uncertainty effects.
The Ugly: Congress Fails to Address the Fiscal Cliff
In light of the recent fiscal debates and the disagreements between the political parties, one cannot completely rule out the possibility that lawmakers simply fail to reach agreement on the fiscal cliff due to continued disagreement over the most controversial tax and spending issues, which hold up agreement on other less controversial provisions.
That said, we view this as a low probability event not only because lawmakers will ultimately want to avoid inducing a recession, but also because they are apt to respond to the inevitable pressure to address the situation that would come from the public, businesses, financial markets. Moreover, a broad swath of lawmakers support averting at least half of the policy changes set to take effect at year end, so even in the worst-case scenario it is unlikely that Congress and the President would allow a permanent lapse in the full range of provisions that make up the fiscal cliff.
Updating our Estimates of Fiscal Drag
We have updated our estimates of the expected effect of fiscal policy on growth. We have incorporated the most recent estimates from the Congressional Budget Office and Joint Tax Committee on the budgetary effects of each of the various components of the fiscal cliff (exhibit 1). These are very similar to prior projections, though the estimated revenue effect of the 2001/2003 tax cuts has grown slightly from estimates earlier this year, while the projected spending cut due to the sequester has declined slightly (Exhibit 1). We have also included “second round” effects on growth in subsequent quarters that result from the direct hit to growth due to fiscal changes.
Estimates of the three scenarios noted above are shown in Exhibit 2. Under the baseline “not so good” scenario, fiscal policy would shave nearly 1½ percentage points from real GDP growth in early 2013, compared with ¾ points in 2012. In this case, we expect a renewed moderate GDP growth slowdown to a 1½% pace in early 2013.
Under the alternative “bad” scenario, the fiscal drag would rise to nearly 2 percentage points in early 2013. This bigger hit, combined with the possible greater uncertainty if an agreement proves elusive for a few weeks in early 2013, would probably cause a sharper slowdown in GDP growth to 1% or less.
Finally, there is the tail risk scenario that Congress fails to agree on any type of resolution for a more extended period, and the economy is hit with both the sequester and much bigger tax increases. While the impact of such a failure—especially those related to confidence and financial conditions—are harder to quantify, just the direct fiscal impact would imply a GDP growth hit of around 4 percentage points in early 2013, and likely a recession.
There is inherent uncertainty in these estimates due not only to unpredictability of the political debate on the fiscal cliff, but also to uncertainty surrounding the effect on growth of different types of fiscal policy changes. Exhibit 3 shows the range of multipliers estimated by the Congressional Budget Office (CBO) for several types of fiscal policy changes. Our own multiplier estimates are in the upper half of the ranges provided by the CBO. We believe that this is reasonable. Recent economic research has demonstrated that fiscal multipliers are relatively large in a depressed economy that is operating at the effective lower bound for nominal short-term interest rates. For example, some studies have used cross-state variation in spending and taxes to isolate the impacts in a situation in which there is no monetary policy offset, and they have generally found rather large multipliers. Our own work using cross-country data and “shutting down” the monetary policy offset to fiscal contraction via statistical analysis has come to similar conclusions.
In addition to these quantifiable drags, we would also expect a negative impact on growth via deterioration in market, business, and consumer confidence. Some of this impact might already occur before the end of the year, as the uncertainty builds. While such an “uncertainty shock” could reverse quickly, providing a large amount of support in a short period of time if a deal is struck, the ride for both the financial markets and the real economy would undoubtedly be rocky.
Famed investor Jeremy Grantham just released his new quarterly letter to GMO clients, and it's depressing. He writes that US economic growth will be less than 1 percent for the next 40 years. This is in contrast to the above 3 percent growth the economy has experienced for as long as we can remember. People take Grantham seriously because he predicted bubbles in Japanese stocks in 1989, U.S. stocks in 2000, and most risk assets in 2007.
In his words:
The U.S. GDP growth rate that we have become accustomed to for over a hundred years – in excess of 3% a year – is not just hiding behind temporary setbacks. It is gone forever. Yet most business people (and the Fed) assume that economic growth will recover to its old rates.
Going forward, GDP growth (conventionally measured) for the U.S. is likely to be about only 1.4% a year, and adjusted growth about 0.9%.
The bottom line for U.S. real growth, according to our forecast, is 0.9% a year through 2030, decreasing to 0.4% from 2030 to 2050 (see table on Page 16). This is all done presuming no unexpected disasters, but also no heroics, just normal “muddling through.
Here are some of the reasons he cites for low future growth:
Population growth peaked in the 1970s, and man-hours worked will grow at around 0.2% per year.
Manufacturing productivity is high, but manufacturing is falling as a share of GDP. Currently it's around 9 percent of GDP. He expects it to fall to around 5 percent by 2040.
Service productivity is low and declining.
Resource costs are rising, and are likely to accelerate. "If resources increase their costs at 9% a year, the U.S. will reach a point where all of the growth generated by the economy is used up in simply obtaining enough resources to run the system."
Climate change will become increasingly unfavorable. He sees more floods and more damage to crops.
Grantham warns that policies that assume 3 percent growth should be taken with skepticism:
Investors should be wary of a Fed whose policy is premised on the idea that 3% growth for the U.S. is normal. Remember, it is led by a guy who couldn’t see a 1-in-1200-year housing bubble! Keeping rates down until productivity surges above its last 30-year average or until American fertility rates leap upwards could be a very long wait!
Here's the table from the GMO letter:
Here are two charts Grantham provides that show how population is working against growth.
Expectations for capital expenditure (investment in growth and maintenance) has plunged in the last few months, while at the same time, consumer sentiment has surged (no doubt led by an ebullient equity market and inherent recency bias). As we wrote previously, in an environment of soaring liquidity and free money, the hurdle rate on new investments collapses, as does the requirement to invest in CapEx, both growth and maintenance. In fact, as we have shown over the past year, the age of the global asset base has hit a record high across the world, both in the developed and developing countries, leading to record low return on assets on record low assets (and record debt encumbrance, but that's a different story). And since companies are forced to dividend cash to shareholders at a record pace (in lieu of fixed income in a ZIRP environment), there is less and less cash left to support CapEx spending (or hiring!).
UMich Consumer Sentiment vs Philly Fed Capex Outlook
So what do CEOs see in the future that consumers do not? Everything
The consumer remains on a path of 'it must mean-revert' - unable to comprehend the new normal that CEOs are dealing with - and sooner rather than later, the personal cashflow will slow/cease (or become ever more encumbered to the state).
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - Nov 18th - Nov 24th, 2012
EU BANKING CRISIS
GLOBAL SHADOW BANKING - Increases $6T to $67T On Total Global GDP of $70T
Earlier today, the Financial Stability Board (FSB), one of the few transnational financial "supervisors" which is about as relevant in the grand scheme of things as the BIS, whose Basel III capitalization requirements will never be adopted for the simple reason that banks can not afford, now or ever, to delever and dispose of assets to the degree required for them to regain "stability" (nearly $4 trillion in Europe alone as we explained months ago), issued a report on Shadow Banking. The report is about 3 years late (Zero Hedge has been following this topic since 2010), and is largely meaningless, coming to the same conclusion as all other historical regulatory observations into shadow banking have done in the recent past, namely that it is too big, too unwieldy, and too risky, but that little if anything can be done about it.
Specifically, the FSB finds that the size of the
US shadow banking system is estimated to amount to $23 trillion (higher than our internal estimate of about $15 trillion due to the inclusion of various equity-linked products such as ETFs, which hardly fit the narrow definition of a "bank" with its three compulsory transformation vectors), is the largest in the world, followed by the
Euro area with a $22 trillion shadow bank system (or 111% of total Euro GDP in 2011, down from 128% at its peak in 2007), and the
UK in third, with $9 trillion.
Combined total shadow banking, not to be confused with derivatives, which at least from a theoretical level can be said to offset each other (good luck with that when there is even one counterparty failure), is now $67 trillion, $6 trillion higher than previously thought, and virtually the same as global GDP of $70 trillion at the end of 2011.
Of note is that while the US shadow banking system has been shrinking (something our readers are aware of, and a fact which in our opinion implies there is nearly $4 trillion more in Fed monetization still to come, as Bernanke has no choice but to offset the credit destruction within shadow conduits, which in turn are deleveraging to the tune of nearly $150 billion per quarter), that of Europe has been increasing.
Aggregating Flow of Funds data from 20 jurisdictions (Argentina, Australia, Brazil, Canada, Chile, China, Hong Kong, India, Indonesia, Japan, Korea, Mexico, Russia, Saudi Arabia, Singapore, South Africa, Switzerland, Turkey, UK and the US) and the euro area data from the European Central Bank (ECB), assets in the shadow banking system in a broad sense (or NBFIs, as conservatively proxied by financial assets of OFIs15) grew rapidly before the crisis, rising from $26 trillion in 2002 to $62 trillion in 2007. The total declined slightly to $59 trillion in 2008 but increased subsequently to reach $67 trillion in 2011.
And while the the bulk of the shadow activity is contained within the 3 well-known jurisdictions (US, Europe, UK) whose credit creation capacity in the traditional banking system appears to have ground to a halt, especially in Europe where unencumbered collateral is virtually nil (thus forcing credit creation in the deposit-free, unregulated shadow space), the FSB also found previously unexplored shadow banks in some brand news venus including Switzerland, China and Hong Kong:
Expanding the coverage of the monitoring exercise has increased the global estimate for the size of the shadow banking system by some $5 to 6 trillion in aggregate, bringing the 2011 estimate from $60 trillion with last year’s narrow coverage to $67 trillion with this year’s broader coverage. The newly included jurisdictions contributing most to this increase were Switzerland ($1.3 trillion), Hong Kong ($1.3 trillion), Brazil ($1.0 trillion) and China ($0.4 trillion).
Not unexpectedly, the FSB focuses mostly on Europe, and provides the following color:
The size of the shadow banking system (or NBFIs), as conservatively proxied by assets of OFIs, was equivalent to 111% of GDP in aggregate for 20 jurisdictions and the euro area at end-2011 (Exhibit 2-3), after having peaked at 128% of GDP in 2007.
The summary is by now well-known to most who realize that the primary driver of marginal credit money creation (in Europe) and destruction (in the US) is none other than the world's shadow banking system. As per Bloomberg:
The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector.
“Appropriate monitoring and regulatory frameworks for the shadow banking system needs to be in place to mitigate the build-up of risks,” the FSB said in the report published on its website.
Sadly, shadow banking, like every other unsustainable aspect of the foundering "modern" financial system, will not be fixed, resolved, or in way improved or made sustainable until the entire system crashes.
What is notable, is that for the first time, the issue that is the lynchpin of virtually infinite shadow banking asset "creation" courtesy of rehypothecation, a topic that came to prominence with the MF Global collapse, and which allows infinite ownership chains on the same asset to be created as long as the counterparties are solvent, to fall under the spotlight, especially the legal loophole to create infinite rehypothecation chains with zero haircuts in the UK (hence geographic arbitrage as noted below). To wit:
Requirement on re-hypothecation
“Re-hypothecation” and “re-use” of securities are terms that are often used interchangeably; they do not have distinct legal interpretations. WS5 finds it useful to define “re-use” as any use of securities delivered in one transaction in order to collateralise another transaction; and “re-hypothecation” more narrowly as re-use of client assets.
Re-use of securities can be used to facilitate leverage. WS5 notes that if re-used assets are used as collateral for financing transactions, they would be subject to the proposals on minimum haircuts in section 3.1 intended to limit the build-up of excessive leverage, subject to decisions taken on the counterparty scope and collateral type (sections 3.1.4 (ii) and 3.1.4 (iii), respectively).
WS5 believes more safeguards are needed on re-hypothecation of client assets:
Financial intermediaries should provide sufficient disclosure to clients in relation to re-hypothecation of assets so that clients can understand their exposures in the event of a failure of the intermediary. This could include, daily, the cash value of: the maximum amount of assets that can be re-hypothecated, assets that have been re-hypothecated and assets that cannot be re-hypothecated, i.e. they are held in safe custody accounts.
Client assets may be re-hypothecated by an intermediary for the purpose of financing client long positions and covering short positions, but they should not be re-hypothecated for the purpose of financing the intermediary’s own-account activities.
Only entities subject to adequate regulation of liquidity risk should be allowed to engage in the re-hypothecation of client assets.
Harmonisation of client asset rules with respect to re-hypothecation is, in principle, desirable from a financial stability perspective in order to limit the potential for regulatory arbitrage across jurisdictions [ZH: ahem UK]. Such harmonised rules could set a limit on re-hypothecation in relation to client indebtedness. WS5 thinks that it was not in a position to agree on more detailed standards on re-hypothecation from the perspective of client asset protection. Client asset regimes are technically and legally complex and further work in this area will need to be taken forward by expert groups.
That the FSB has no idea how to regulate infinite rehypothecation should come as no surprise to anyone. After all, enforcing limits on creating "assets" out of thin are would limit the amount of millions Wall Street CEO can pay themselves in exchange for creating soon to be vaporized ledger entries, which they "do not recall" how those got there upon Congressional cross examination.
Finally, perhaps the most important section of all deal with what the FSB terms "Facilitation of credit creation."
Facilitation of credit creation
The provision of credit enhancements (e.g. guarantees) helps to facilitate bank and/or non-bank credit creation, may be an integral part of credit intermediation chains, and may create a risk of imperfect credit risk transfer. Non-bank financial entities that conduct these activities may aid in the creation of excessive leverage in the system. These entities may potentially aid in the creation of boom-bust cycles and systemic instability, through facilitating credit creation which may not be commensurate with the actual risk profile of the borrowers, as well as the build-up of excessive leverage. Credit rating agencies also facilitate credit creation but are outside the scope as they are not financial entities.
Examples may include:
Financial guarantee insurers that write insurance on financial products (e.g. structured finance products) and consequently facilitate potentially excessive risk taking or may lead to inappropriate risk pricing while lowering the cost of funding of the issuer relative to its risk profile. – For example, financial guarantee insurers may write insurance of structured securities issued by banks and other entities, including asset-backed securitisations, and often in the form of credit default swaps. Prior to the crisis, US financial guarantee insurers originated more than half of their new business by writing such insurance. While not all structured products issued in the years leading up to the financial crisis were insured, the insurance of structured products helped to create excessive leverage in the financial system. In this regard, the insurance contributed to the creation of large amounts of structured finance products by lowering the cost of issuance and providing capital relief for bank counterparties through a smaller capital charge for insured structures than for non-insured structures. Because of large losses on structured finance business, financial guarantee insurers have in some cases entered into settlement agreements with their counterparties under which, for the cancellation of the insurance policies, the counterparties accepted some compensation from the insurer in lieu of full recovery of losses. In other cases, financial guarantee insurers have been unable to pay losses on insured structured obligations when due. These events exacerbated the crisis in the market.
Financial guarantee companies whose funding is heavily dependent on wholesale funding markets or short-term commitment lines from banks – Financial guarantee companies may provide credit enhancements to loans (e.g. credit card loans, corporate loans) provided by banks as well as non-bank financial entities. Such financial guarantee companies may be prone to “runs” if their funding is heavily dependent on wholesale funding such as ABCPs, CPs, and repos or short-term bank commitment lines. Such run risk can be exacerbated if they are leveraged or involved in complex financial transactions.
Mortgage insurers that provide credit enhancements to mortgages and consequently facilitate potentially excessive risk taking or inappropriate pricing while lowering the cost of funding of the borrowers relative to their risk profiles – Mortgage insurance is a first loss insurance coverage for lenders and investors on the credit risk of borrower default on residential mortgages. Mortgage insurers can play an important role in providing an additional layer of scrutiny on bank and mortgage company lending decisions. However, such credit enhancements may aid in creating systemic disruption if risks taken are excessive and/or inappropriately reflected in the funding costs of the banks and mortgage companie
Why is this section so imporant? Because recall that in a Keynesian system, credit creation = money creation = growth. Without "facile" credit creation, there is no growth period. The problem, however, is that the world is approaching its peak credit capacity across the various verticals: sovereign, financial, corporate non-financial, shadow, and of course, household. The reality is that unless some existing debt is not eliminated to make space for future "credit creation", there simply can not be growth, and the problem is that wiping out credit, means the equity tranches below it are worthless. And that is the Catch 22, because wiping out equity somewhere in the world, would have dramatic implications not only on the wealth of the 0.0001% but on credit and faith in a system, which only operates due to the inherent "credit" (hence the name) and "faith" in it. Without those, ultra-modern finance crumbles like a house of cards.
In other words, while the FSB, like any other prudent regulator, is diligently warning about the dangers associated with unprecedented leverage across shadow, and all other systems, in reality what it is saying is that the only way to resolve a record debt problem is... with more debt.
And so we are back to square zero, only this time we are a few trillions dollars closer to complete systemic debt saturation.
* * *
For more on the topic of Shadow Banking, we suggest the following reading material:
The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight.
The FSB, a global financial policy group comprised of regulators and central bankers, found that shadow banking grew by $41 trillion between 2002 and 2011.
The share of activity based in the U.S. has declined from 44 percent in 2005 to 35 percent in 2011, moving to the U.K. and the rest of Europe.
The size of the shadow banking system, which includes the activities of
money market funds,
monoline insurers and
off- balance sheet investment vehicles,
“can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector. “Appropriate monitoring and regulatory frameworks for the shadow banking system needs to be in place to mitigate the build-up of risks,” the FSB said in the report published on its website.
While watchdogs have reined in excessive risk-taking by banks in the wake of the collapse of Lehman Brothers Holdings Inc. in 2008, they are concerned that lenders might use shadow banking to evade the clampdown. Michel Barnier, the European Union’s financial services chief, is planning to target money market funds in a first wave of rules for shadow banks next year.
Supervisors consider shadow banking activities to be those that allow banks to carry out business off balance sheets, as well as those which allow investors to bypass lenders and the functions they traditionally fulfill on the markets.
The FSB also targeted repurchase agreements and securities lending for tougher rules, recommending that regulators implement minimum standards for calculating losses on the different types of collateral used in the transactions.
Repurchase agreements are contracts where one investor agrees to sell a security and then buy it back at a future date and a fixed price. Securities lending agreements involve institutional investors such as pension funds lending financial instruments against cash collateral.
The group is also concerned that regulators are unable to monitor the scale of the trades. Supervisors should “collect more data on securities lending and repo exposures amongst large international financial institutions with high urgency,” the FSB said in the report.
Large firms should disclose more information about the deals to investors, the FSB said, and may be required to publish regular statements detailing how much collateral they have and what it is used for.
A bankruptcy examiner’s report found that Lehman used so- called Repo 105 transactions to move as much as $50 billion temporarily off its balance sheet to convince investors it wasn’t carrying too much debt.
Final rules will be submitted to leaders of the Group of 20 nations at a summit in St. Petersburg, Russia, next year, the FSB said. Mark Carney, chairman of the FSB, said earlier this month that regulators are holding “intense discussions” on shadow banks.
...using customer money to fund loans. The FSB is right to be concerned. Shadow banking...their leveraging power and profits. The FSB’s concerns are not limited to banks...cyclical effects, poor execution of the FSB’s plans could stifle the more productive...
...early discussions of shadow banking, the FSB was careful to say that some shadow banking...lending in the “repo” markets. The FSB has also proposed tighter rules on “rehypothecation...Tucker, Bank of England official and an FSB member, who has suggested that minimum... By Brooke Masters in London
The FSB wants stricter controls on shadow banking: Minimum repo haircuts...maintain constant net present value are among measures that the FSB will push for. (Financial Times)(FSB overview - PDF) EU makes budget plans without UK: EU officials... Kate Mackenzie
...regulating shadow banking. And in particular, the FSB likes the stable NAV requirement. From the FSB's consultative document published yesterday...of Securities Comissions came up with at the FSB's behest (scroll down for the FSB's response... Kate Mackenzie
...tougher regulations, these look increasingly likely now that the FSB is supporting similar measures to Shapiro's as part of it...Friday between President Barack Obama and leaders in Congress. FSB seeks to tame shadow banking: Non-bank lending markets face... Masa Serdarevic
...and which parts are dangerous. The latest FSB data show that “other financial institutions...is hardly a precise definition, and the FSB was careful to say that it did not have...Lord Turner, the UK regulator who led the FSB’s work. Either, they create credit... By Brooke Masters in London
Something to chew on besides Thanksgiving Turkey during the Holiday break. Below is a recap of the latest Fiscal Cliff analysis.
What Is the Fiscal Cliff?
The term ‘fiscal cliff’ is shorthand to describe the mix of $607 billion in U.S. taxes and spending that are scheduled to expire on Dec. 31, 2012. The mix of tax and spending cuts include the Bush era tax cuts, the 2010 Obama tax holiday, partial expensing of investments and the onset of tax provisions to support the implementation of the 2010 Affordable Health Care Act. Accompanying theses tax measures are spending changes that include the expiration of emergency unemployment benefits, a scheduled reduction in Medicare payment rates, and the start of what is referred to as “automatic sequestration” or across-the-board cuts in discretionary and defense spending under the 2011 Budget Control act.
It's past time to blunt the tax shock set to strike in January. According to the nonpartisan Congressional Budget Office, tax revenue in calendar 2013 will jump by nearly a half-trillion dollars, which comes to about 2.7% of nominal gross domestic product. There hasn't been a single year since 1970 when increases in federal tax revenue ran even as high as 1% of nominal GDP. But in 1969, the rise ran 2.1%, and by that year's fourth quarter, the U.S. was in recession.
Since I wrote about the tax shock last week ("Shock Treatment," Nov. 12), policy makers have held sit-downs, both formal and informal, to try to forestall it. With informal talks already under way between White House and congressional staff, President Obama held a meeting Friday, attended by congressional leaders, including Republican House Speaker John Boehner, from which nothing conclusive resulted. There were, however, postmeeting assurances that the talks had been "constructive." My colleague Jim McTague, in his column, seems confident that
a deficit-reduction deal will be worked out early next year,
preceded by passage of a measure this year to prevent our going over the cliff.
But a true deficit-cutting plan could take longer.
Regardless of your view, you can't follow the game without a score card. Herewith, a summary of the main issues:
THE MEDIA SEEM TO BE SOWING CONFUSION about whether the talks are really about reducing the deficit, or about increasing it. Answer: To avert the fiscal cliff, or blunt the tax shock, policy makers must, over the next 12 months, do the unthinkable by widening the deficit, not narrowing it. But plans should also be put in place over the long run to phase in a narrowing of deficits that keep adding to a federal debt that now stands at 70% of nominal GDP, a level not seen since shortly after World War II.
Cynics about the political process could make a fair case for a very different course of action. Our leaders are being told to be fiscally conservative over the long run and fiscally profligate over the short run. What if, given their profligate nature, they heed the second admonition, but ignore the first? If that were likely to happen, there might be a case for accepting the fiscal cliff, and the risks it poses of recession, because the bust that could ultimately occur if deficits are allowed to mount would be far worse.
But there is one key point the cynics should consider. Those concerned about the looming debt generally favor spending reductions over tax increases. And averting tax increases is what averting the fiscal cliff is mainly about.
I have argued that this tax shock is the main threat, since the spending cuts are essentially illusory. The cuts that are supposed to occur via "sequestration" will be more than offset by increases in spending on entitlements. The projections of the CBO and the White House Office of Management and Budget both show spending climbing in 2013.
The agreement forged to handle the fiscal cliff may postpone the sequestration, resulting in even bigger spending increases. But given the arithmetic, most of that agreement will necessarily involve postponing the tax hikes.
THE GRAPHIC BELOW , which itemizes the main components of the tax shock, adds up to $506 billion. To put that figure in context, nominal gross domestic product now stands at $15.8 trillion, of which $506 billion is 3.2%, even more than the 2.7% projected by the CBO.
Nominal GDP in the third quarter grew at an annual rate of 5%. So if we take 5% as our baseline, and assume a dollar-for-dollar hit to GDP growth, we would still get nominal gross domestic product running positive, and real GDP running about flat. To get an outright contraction in real GDP growth, we must assume a hit per dollar of more than a buck of GDP -- a shock that's quite possible.
But the building blocks of that tax shock show a way to blunt it. Boehner favors lower taxes for everyone, including the wealthy. Obama wants to sock it to the wealthy and extend tax relief to everyone else.
Accordingly, both favor
extending the Bush tax cuts for lower brackets (worth $95 billion),
extending the exemption on the alternative minimum tax ($114 billion), and
extending part of the estate-tax holiday ($14 billion). And, according to a story in Reuters,
support also is building for extending the payroll-tax holiday ($120 billion).
Those figures add to $343 billion, or more than two-thirds of the tax shock. Call that shock effectively blunted.
WHAT MIGHT REALLY HAPPEN? Cato Institute Budget Analyst Chris Edwards believes that, before this year's congressional session ends, all parts of the looming fiscal cliff will be officially postponed, at least until the middle of next year. That will include delaying tax hikes on the top brackets, along with the delay of sequestration. The second, more important part of the job -- taming the debt and deficits -- will have to wait until next year.
This is a very useful chart here from Deutsche Bank breaking down various components of the so-called "Fiscal Cliff," the series of spending cuts and tax hikes that will kick in on January 1.
It might come as a surprise to you that one of the largest single components of the fiscal cliff is the Payroll Tax Holiday, a stimulus measure that was passed by Obama and the Congress (Deutsche Bank has it as the largest single component of the cliff, although Goldman Sachs has slightly different math).
The Bush Tax cuts and the sequester get way more play in the media, but the payroll tax cut stimulus is a huge component.
2- Sovereign Debt Crisis
Fiscal Cliff Poses Significant Risk to U.S. Outlook
The so-called ‘fiscal cliff,’ the confluence of $607 billion in expiring tax and expenditure policies set to take effect at the end of 2012, poses a significant risk to the U.S. economic outlook. Unless lawmakers reach a compromise to extend some or all of the temporary tax cuts and postpone mandatory spending cuts, the hit to the economy would translate into about 4 percent of gross domestic product.
The current Bloomberg consensus forecast is for a growth rate of 2 percent in 2013, with 1.9 and 2.3 percent rates of expansion in the first two quarters of next year. Should Congress delay acting until early 2013 to address these issues, growth will likely slow to less than 1 percent during the first half of next year. Persistance of financial gridlock would probably push the economy into recession in the first half of 2013.
The expiration of the temporary measures needs to be placed in the broader context of long-term deficit and debt dynamics faced by the U.S. federal government.
Policy choices made in the near-term will affect the economy for years to come. If not addressed, current debt and spending dynamics will probably lead to a reduced growth path, placing at risk expenditures on vital social programs and, over time, crowding out private sector borrowing that funds the gross private domestic investment necessary to boost productivity and living standards.
Periods with greater investment as a share of GDP are highly correlated with both faster economic growth and rising living standards. One risk to the U.S. economy is that rising entitlement spending will require the government to borrow from the finite amount of capital held by private savers, thus squeezing out private firms that need the capital to expand businesses and increase productivity.
Dollars spent on entitlements dwarf those spent on discretionary items such as education, and tower over net fixed business investment, which is partially responsible for greater productivity, business expansion and rising living standards.
U.S. federal spending on mandatory entitlements will probably increase from $2 trillion in 2012 to $2.8 trillion in 2017. Spending on entitlements as a share of GDP increased from 4.9 percent in 1962 to an estimated 13.5 percent in 2012. In contrast, net fixed business investment will probably decline to 1.7 percent in 2012 from 3 percent in 1962.
This special edition of the Bloomberg Economic Brief intends to present the substantial short-term risk to the outlook within the context of the long-term challenges faced by policy makers to help facilitate decision-making by investors.
The economic impact of permitting the combined tax and spending measures to expire is stark. First, firms are already paring back investment and hiring, and households have stepped up their rate of savings, most likely to smooth out consumption to account for reduced after-tax income next year, and thereby contributing to the current slow pace of growth.
Second, real GDP will likely show negative growth rates of minus 2.2 percent in the first quarter and minus 1.3 percent in the second quarter, with a modest recovery in the second half of the year. The result will be higher unemployment, falling taxable income and a mild recession in early 2013.
COMPOSITION OF THE CLIFF
Although the gross impact of the “fiscal cliff” is about $607 billion, once one accounts for the impact of lower spending on the fiscal deficit, the net impact is roughly $560 billion.
The mix of tax and spending cuts include the Bush era tax cuts, the 2010 Obama tax holiday, partial expensing of investments and the onset of tax provisions to support the implementation of the 2010 Affordable Health Care Act. Accompanying theses tax measures are spending changes that include the expiration of emergency unemployment benefits, a scheduled reduction in Medicare payment rates, and the start of what is referred to as “automatic sequestration” or acrossthe- board cuts in discretionary and defense spending under the 2011 Budget Control act.
Government spending will need to be brought into alignment with revenues over the next several years to bring the primary budget – spending, excluding net interest on the debt – into balance and to stabilize the long-term debt of the U.S. to ensure the health of the economy and viability of current entitlement programs.
Through the first 10 month of fiscal year 2012, the federal government has run a deficit of $975 billion, indicating that the U.S. is likely to run a deficit in excess of $1 trillion for the third consecutive year.
For economists, deficits are a flow concept, referring to the relative shortfall between taxes and outlays in a specific period of time. The deficit is on pace to come in at about 8 percent of GDP this year, slightly narrower than 8.2 percent at the end of fiscal year 2011.
The level of debt is a stock concept, showing the total accumulation of debt over time.
Total public debt currently stands at around $15.2 trillion, which translates to a total debt-to-GDP ratio of more than 100 percent. Research conducted by Kenneth Rogoff and Carmen Reinhart indicates that persistent debt-to-GDP ratios of greater than 90 percent tend to be associated with drags on overall growth of 1 percent.
Stabilizing the overall debt is a key component of longer-term fiscal sustainability that includes not only moving the primary budget towards balance, but also reducing the debt-to-GDP ratio while implementing policies to boost nominal growth and keep interest rates low.
Currently, the federal government is running a primary deficit, netting out interest payments on past debt, of roughly 6 percent of GDP.
Nominal growth over the past year is roughly 3.9 percent and long term borrowing costs are about 1.5 percent. Assuming these levels, the federal government would be able to run a primary budget deficit around 3 percent and stabilize the debt-to-GDP ratio at near 100 percent.
This implies that in coming years the government will have to pare back annual spending by about $500 billion to ccomplish these goals.
One reason why the U.S. Federal Reserve has committed to keeping the policy rate effectively at zero until late 2015 is the lack of fiscal action, or comprehensive tax and entitlement reform, to boost overall economic activity and employment. Essentially, policy gridlock in Washington has put the Fed is in the uncomfortable position of attempting to buy time for the federal government to get the U.S. fiscal house in order.
The simple exercise above to identify spending reductions necessary at current low interest rates necessary to stabilize the debt-to-GDP ratio at 100 percent also shows that an increase in long-term interest rates would require even more fiscal restraint in non-discretionary, defense and entitlement spending.
Should current policies remain in place, the gap between revenues and spending will grow, creating a much larger problem and forcing policy makers to make politically unpalatable choices.
There will probably be little movement to address the economic consequences of the fiscal cliff until after the November U.S. presidential election. This will leave policy makers the one-month lame duck session of the 112th Congress between Nov. 13 and the currently scheduled day of adjournment on Dec. 14 to reach a decision before the scheduled tax increases and mandatory spending cuts will take effect Jan. 1.
Given political polarization, these issues may well not be addressed until the start of the 113th Congress on Jan. 3, 2013. Regardless of the outcome of the election and the composition of the new Congress, slower growth and weak hiring and consumption are likely for the remainder of this year and early 2013.
FISCAL CLIFF & THE FED
In his Sept. 13 press conference, Federal Reserve Chairman Ben Bernanke indicated that the Fed does not possess tools strong enough to offset the effects of a major fiscal shock. Given the Fed’s track record during the financial crisis, and through the recovery and anemic expansion, the central bank will probably seek to lengthen its maturity extension program and restart purchases of long-term government securities ahead of any potential fiscal shock following the election. Since September 2011, Operation Twist has resulted in a shift of the weighted average maturity of the Fed’s portfolio holdings to 9.5 years from about 6 years.
With U.S. gross domestic product in the third quarter of 2012 tracking near 1.3 percent, external demand slowing, and the manufacturing sector looking increasingly vulnerable, there is little on the horizon that suggests a major boost to growth during the final three months of the year. Thus, it is probable that the Fed will use the Dec. 12 meeting of the FOMC to announce, at a minimum, that it will lengthen its maturity extension program to help mitigate the effects of a shock to the economy should lawmakers fail to resolve the fiscal cliff.
Should the outcome of the upcoming election be further polarization in Washington, therefore increasing chances policy makers may allow a fiscal shock, the Fed may entertain the idea of another round of unsterilized long-term Treasury purchases to complement its open-ended mortgage-backed security acquisitions.
A failure by policy makers to address the fiscal cliff in 2012 may provide an opportunity for fixed income investors to profit well in advance of the beginning of next year. The Fed currently holds roughly $1.28 trillion in long-term Treasuries and $931 billion in Federal agency mortgagebacked securities debt.
2- Sovereign Debt Crisis
View from the Street - Bloomberg Brief
“We expect S&P 500 will fall sharply following the election when investors finally recognize the serious possibility that the ‘fiscal cliff’ problem will not be solved in a smooth fashion. Goldman Sachs assigns a one-in-three likelihood Congress does not address the situation before Jan 1st. In contrast, our conversations suggest the vast majority of clients expects the ‘fiscal cliff’ issue will be addressed during the lame duck session of Congress.”
— Goldman Sachs Global Economics, Commodites and Strategy Research team
"In a base case scenario, lawmakers delay tax hikes and recast spending cuts, leaving roughly a percentage point of fiscal drag and a relatively benign near-term outlook for modest growth. Nonetheless, with general government debt already topping 100%, this outcome leaves the U.S. dangerously exposed to an abrupt loss of market confidence and a fiscal crisis as near-term debt continues to outrun GDP."
— Citigroup Economics, Nathan Sheets, Robert DClemente, Peter D’Antonio
“Mr. Bernanke himself has stated in no uncertain terms that monetary policy will be unable to offset the negative economic impact of the fiscal cliff. He is therefore warning that the fact that the Fed has used all its available tools does not mean the US economy will escape unscathed from a plunge over the fiscal cliff.”
— Richard Koo, chief economist, Nomura Research Institute
“If the fiscal cliff isn’t addressed, as I’ve said, I don’t think our tools are strong enough to offset the effects of a major fiscal shock, so we’d have to think about what to do in that contingency.”
— Ben S. Bernanke, Federal Reserve chairman
“We could face substantially more restrictive fiscal conditions if federal budget negotiations fail to resolve the issues surrounding the so-called fiscal cliff. And for both the global situation and the U.S. fiscal cliff, there is a lot of uncertainty over what the eventual outcomes will be.”
— Charles Evans, Federal Reserve Bank of Chicago
“Reductions in taxes or increases in spending in 2013, relative to what would occur under current law, would have near-term economic benefits but would add to the already large accumulation of government debt. Because current policies would ultimately lead to an unsustainable level of federal debt, policy makers will need – at some point – to adopt policies that will require people to pay significantly more in taxes, accept substantially less in government benefits and services, or both.”
— Congressional Budget Office, “An Update to the Budget andEconomic Outlook: Fiscal Years 2012 to 2022”
“Some clients in recent meetings have argued that the fiscal cliff will not happen because politicians in Washington know that the economic fallout will be too great. We agree that the full fiscal contraction implied by current law (about 4 percent of GDP) will be avoided. But we have emphasized two points. First, there is likely to be some fiscal hit, on the order of 1-2% percent, no matter the outcome of the election. Second, uncertainty regarding the Cliff is already undermining the economy and it could very well culminate in financial market riot points as deals to avoid the Cliff and raise the debt ceiling are done at the 11th hour, and with great acrimony.”
— BCA Research, Sept. 24 Weekly Report
“We think the Fed will buy $85 billion a month ($45 billion in Treasuries, as it is doing until year-end in Operation Twist, and $40 billion in the new MBS purchases) for some time, and that amount will be fairly insensitive to new data. It’s possible the Fed will adjust that total in December, given the scheduled expiration of Operation Twist, but that may be too soon to judge the likely outcome of the fiscal cliff at year-end.”
— Renaissance Macro Research, Sept. 24
“While the limit on spending authority will be imposed at the beginning of the year, the actual reductions in spending will occur over the course of the year and into subsequent fiscal years. Once again, only a fraction of the impact occurs in the first month or so, although expectations of the cutbacks can affect the behavior of government contractors and others in advance of the actual cuts.”
— Chad Stone, chief economist, Center on Budget and Policy Priorities
“In our view, the U.S. economy is being hit with an uncertainty shock because of the looming fiscal cliff. Our forecast assumes that the uncertainty shock slows growth to 1.0 percent in the fourth quarter of this year.”
— Bank of America Merrill Lynch, U.S. Economics report, Sept. 24
“The prospect of a continued division of power in Washington – and consequent political gridlock – increases the risk that the Bush tax cuts are allowed to expire, raising the risk that the dividend tax rate rises substantially relative to that on capital gains. With utility stocks much more exposed to this risk than other defensive assets, such as bonds, we recommend that investors lighten their positions in the sector until the relative tax treatment of dividends and capital gains is resolved in the aftermath of the November elections.”
— Hugh Wynne, senior analyst, Sanford C. Bernstein
..... Commenting on the Nov 6th election results, Mr Paul lamented that the US-economy has already veered over the "Fiscal Cliff," and that the nation is being transformed into a European style socialist welfare state. Mr Paul sees no chance of righting the ship in a country where too many people are already dependent upon $1-trillion of welfare assistance provided by states and the federal government. "We're so far gone. We're already over the cliff. We cannot get enough people in Congress in the next 5-to-10-years who will do wise things."
Mr. Paul, who is retiring after 12-terms in the House, said "The people in the Midwest voted against Romney: 'Oh, they have to be taken care of!' So that vote was sort of like laughing at Greece. People do not want anything cut. They want all the bailouts to come. They want the Fed to keep printing the money. And they don't believe that we've gone off the cliff or are close to going off the cliff. They think we can patch it over, that we can somehow come up with some magic solution. But you can't have a budgetary solution if you don't change what the role of government should be. As long as you think we have to police the world and run this welfare state, all we are going to argue about is who will get the loot," Paul added.
During Mr Obama's first term in office, US-federal spending jumped +18% to a record $3.52-trillion and spending has remained constant since then. There's never been a serious effort to cutback on expenditures. As a result, the US-government has run deficits totaling $5.1-trillion over the past four years. There's never been a string of budget deficits that even remotely approaches these staggering amounts; the last year of George W. Bush's tenure, the previous record budget deficit was $459-billion. In order to finance these budget deficits, the White House has mostly relied upon the Federal Reserve and foreign central banks, to buy the lion's share of the newly auctioned Treasury debt, and to a lesser extent, risk adverse investors fleeing the stock markets and Euro-zone bond markets, have been avid buyers.
Scaling the Fiscal Cliff - Now that the Nov 6th election is over, the vast majority of the US-public is learning for the first time about a dirty little secret, - it's called the "Fiscal Cliff," and it refers to a wicked combination of $500-billion of tax increases and $110-billion of spending cuts that will take effect next year, unless the Republicans in the House and the Obama White House can agree on ways to turn the cliff into the "Fiscal Hill." Both political parties recognize the need to pare down the size of future budget deficits, in order to maintain the solvency of the country over the longer-term. There is no way to avoid the fiscal cliff, and if a recession ensues next year, both sides want to be able to win the public relations war, by pinning the blame for the fallout on the other political party.
The basic Republican framework for tackling the fiscal cliff calls for a reduction in spending on entitlements and capping social welfare programs. The fiscal cliff also provides tax reformers with a golden opportunity to overhaul the tax code, - by eliminating many of the deductions and credits, that reduce tax payments from individuals and corporations by about $1-trillion per year. Republican leaders are willing to eliminate many loopholes that disproportionately benefit the higher-income earners and scale back deductions for the business sector that earned $1.5-trillion in after-tax profits in the past 12-months. "In a good-faith effort to make progress on boosting the economy and government's long-term solvency, Republicans like me are open to new revenue in exchange for meaningful reforms to the entitlement programs," said Senate Minority Leader Mitch McConnell (R-Ky.) on Nov 13th.
The War on the Ultra-Wealthy - Mr Obama owes a big debt of gratitude to Fed chief Ben Bernanke, who helped to engineer his re-election, by masterminding a improbable +3,000-point rally in the Dow Jones Industrials from the Oct 4th, 2011 low of 10,500, to above 13,500 in Sept '12. The rally helped to boost US-consumer confidence, and lifted Obama's approval rating with a sizeable segment of the voting population. However, now that Obama has been re-elected to a second term, his emphasis is already shifting 180-degrees, - from boosting the fortunes of the Ultra-wealthy, - that's heavily tied-up in the artificially inflated - stock market, - to waging war on the Ultra-wealthy, by aiming to hike their tax rates on dividends, capital gains, and ordinary income. Such a move is expected to raise about $80-billion in extra revenues for the US Treasury, according to some estimates.
Mr Obama will begin talks on the Fiscal Cliff with a proposal to raise $1.6-trillion in new tax revenue, with 80% of the tax increases paid by high-income earners, and 20% from Corporate America. That means the top-1% would pay $121,000 more in taxes each year. The top 20% of income earners would pay an average $14,000 more each year. That's important, because the top-1% of the wealthiest Americans own 38% of the stocks traded on the NYSE and Nasdaq. The next 9% tier of wealthy investors control 44% of the total shares. Jacking up taxes on capital gains and dividends and eliminating tax loopholes for Corporate America has spooked the top-10% richest investors, into dumping their stocks before year end.
"When it comes to the top-2%, what I am not going to do is extend further a tax cut for folks who don't need it which would cost close to a $1-trillion. The math does not work, in some proposals to raise taxes on the wealthy by just closing tax loopholes," Obama said on Nov 14th. Obama said he is "very eager" to reform the tax code, (ie eliminate many of the tax loopholes for Corporate America), and said entitlements like Medicare and Social Security need a "serious look as part of a deficit deal." While there is no sympathy for the Ultra-wealthy, the broader US-economy would be at risk of a renewed downturn, because tackling the fiscal cliff would require some degree of "fiscal austerity," just like in recession ravaged Europe.
At the end of the day, no matter what amount of austerity is agreed upon, the US-federal government is still expected to run a budget deficit of $700-billion or more. In order to finance the shortfall, traders can expect the Obama White House to call upon the political puppets that sit at the Federal Reserve, to create hundreds of billions of electronically printed US-dollars through its Infinity QE-3 program. That message has already been transmitted to the Fed. At the Fed's October meeting, a number of Fed officials spoke about the need to step-up Treasury bond purchases next year. Fed deputy Janet Yellen said that the federal funds rate could stay locked near zero-percent until early 2016 in order to help keep the US-Treasury's financing costs as low as possible. Through the Fed's totalitarian control of credit, - financing the US Treasury can be done cheaply in spite of the mushrooming of the national debt, - until an inflection point is reached, where hyper-inflation begins to take-off.
The Fed slashed the overnight federal funds rate to near zero-percent in December 2008 and has pumped $2.3-trillion of freshly printed dollars into the money markets. In turn, investors seeking a safe haven from the debasement of paper money, turned to Gold, - bidding-up the price of the yellow metal from $700 /oz four years ago, to above $1,700 /oz today. The price of Silver nearly quadrupled from $9 /oz to above $32 /oz today. Gold Bugs and Silver Bulls alike can breathe a big sigh of relief, knowing that Bernanke will have his fingers on the printing press in the year ahead. Since Sept 13th, the Fed has begun printing $40-billion per month, an open-ended scheme, with no pre-determined timeline. Mrs Yellen, an addicted money printer, advocates a "highly accommodative policy," even "if inflation overshoots the Fed's 2% inflation target objective for several years," she said.
Many investors have turned to exchange traded funds (ETF's), listed on the stock exchanges which issue securities backed by physical holdings of Gold. Demand for these funds has increased five-fold since July 2006. Collectively, they hold 75-million ounces in the vaults, - that's up from 14-million ounces in July of 2006. Gold is a highly liquid vehicle that can preserve an investor's purchasing power over the longer-term. In fact, the central banks that are the world's most notorious money printers were net buyers of 252-tons of Gold in the first half of 2012, after purchasing 456-tons in the year before.
Historically the bond market has been a disciplining force for policymakers. When the Fed was too soft on inflation or the fiscal deficit was out of control, interest rates spiked higher. In our view, this has changed and today the stock market is the disciplining force for Washington. Stocks have generally endorsed Fed policy. We estimate that stock prices rose a cumulative 15% in the past three years in response to Fed announcements or actions. While some investors have misgivings about what the Fed is doing, the overall market likes it. By contrast, the stock market is giving a clear no-confidence vote to fiscal policymakers. This was particularly clear when the TARP bailout plan failed to pass and at the end of the debt ceiling debate.
The Grand Distraction
The post-election discussion underscores the futility of trying to get a quick “grand bargain,” putting in place a long-term plan for deficit reduction. Speaker Boehner has emphasized that any increase in tax revenues should come from broad-based reform: “in order to garner Republican support, the President must be willing to reduce spending and shore up the entitlement programs that are the primary drivers of our debt.” While tax and entitlement reform are good long term goals, are they really feasible in a few months?
A near-term grand bargain faces not just one, but four major hurdles:
A low starting point: Neither party has even scratched the surface in presenting a feasible plan for either tax or entitlement reform, in our view. Tax reform requires tough choices around which loopholes to cut, a topic that has been carefully avoided by both parties. Medicare reform also requires tough choices around how care is rationed. Republicans have offered a voucher plan, but haven’t mentioned that it will only reduce costs if patients have large out-of-pocket expenses so they have an incentive to limit their spending. Democrats have offered to cut payments to providers, but without any impact on service. The American public needs to be educated about the true options it faces.
Bi-partisan cooperation: As was clear in the 1986 tax reform, getting complicated and contentious reforms enacted is very hard without true cooperation, particularly with relatively evenly divided government. The leaders of the two parties have to stand together and fight the special interests.
High complexity: The US tax code is extremely complicated and any attempt to change it creates many winners and losers. It has big impacts on the many special interests with tax advantages. It also redistributes income across not just income classes but between states (ironically, high-income people in the “Blue states” that voted for the Obama have the most to lose since those states tend to have high mortgages and high state and local taxes). If anything, Medicare reform is even more difficult since it involves life and death choices and there are fundamental disagreements about the relative role of markets and administration in controlling costs.
A sizable gap in view: The two parties strongly disagree about how tax reform impacts the economy. Republicans argue that most of the revenue from tax reform will come from creating a stronger economy. In the past week, President Obama countered: "What I will not do is to have a process that is vague, that says we're gonna sorta, kinda raise revenue through dynamic scoring or closing loopholes that have not been identified."
We agree that it is important to start laying the ground work for tax and entitlement reform, but we also believe it is also important to get the sequencing right. First, dismantle the fiscal cliff, and then start negotiations on the longer term solutions.
Japan might offer a glimpse of what developed economies may look like in the future (aging, non-growing, zero population growth, etc.). And then beyond that, the Japanese election features one candidate -- former PM Shinzo Abe of the Liberal Democratic Party -- who is running on an explicitly pro-QE, pro-inflation platform that is unusual.
Already the Japanese yen is at 7-month low (against the dollar) and folks on Wall Street are betting on much more weakness to come.
Morgan Stanley's just-released 2012 FX outlook is titled "2013: The Year Of JPY Weakness." They write:
With early elections less than a month away, and with the current administration’s approval rating at depressed levels, popular polls show that the LDP’s Abe will almost certainly become Japan’s next Prime Minister by year-end. This will have large ramifications on FX markets, given how vocal he has been on defeating deflation and currency strength. Specifically, Mr. Abe is pushing for
The BoJ to cut the benchmark rate to zero or lower,
Intervene in unlimited amounts, and
Adopt an inflation target of up to 3%.
Additional pressure on the central bank to act more aggressively should catalyze sustained JPY weakness, in our view. Indeed, the current structure of the FX market suggests that JPY weakness will beget further weakness. On the one hand, the Japanese private sector has amassed short-term external debt of roughly US$1.8 trillion. With little incentive to raise debt at higher rates abroad, this suggests to us that these positions are used to currency-hedge longer-duration USD investments. According to our calculations, the Japanese private sector is now almost fully hedged.
On the other hand, over the past two years, net portfolio inflows into Japan have been almost entirely in the money markets. With Japanese money market instruments providing no yield, foreign investors have bought these investments in the hope that JPY appreciation ‘pays the dividend’. As such, with the BoJ likely to engage in a much more aggressive easing stance, this should drive not only an unwinding of currency hedges, but also an outflow from the Japanese money market. We believe that the combination of these flows will drive JPY materially weaker – we target 92.00 next year.
As for the actual election, at this point, there doesn't seem to be much doubt that Abe will win.
The Gaza Conflict Reverberates in the West Bank and Jordan 11-19-12 Stratfor
A Palestinian who was wounded Nov. 17 during protests in the West Bank against Israel's ongoing operations in the Gaza Strip has died from his injuries, the Palestinian Ma'an news agency reported Nov. 19. The West Bank has been calm in recent years, but significant protests have been taking place across the eastern Palestinian territory -- which is ruled by Hamas' secular rival, Fatah -- in response to Israel's Operation Pillar of Defense. The protester's death could widen that unrest.
These developments have implications in Jordan, where the regime of King Abdullah II is also struggling with political unrest. The duration of the Israeli-Gaza conflict will determine the extent of the brewing unrest in the West Bank and the toll it has on Jordan.
The ongoing conflict between Hamas and Israel has generated a significant amount of sympathy for Hamas in the West Bank. In some parts of the territory, anti-Israeli youth protesters have thrown stones and Molotov cocktails at Israeli security forces patrols. The protests, while at a low level for now, complicate matters for the administration of Palestinian President Mahmoud Abbas.
While the Arab Spring created conditions that increased the power of Hamas, it also added to the woes of Fatah, which has been deteriorating for some time. The group suffers from an aging leadership, internal splits, corruption charges amid poor economic conditions in the West Bank and a failure to make progress toward Palestinian statehood in negotiations. Thus, it is no surprise that Fatah, despite its deep animosity toward Hamas, has come out in support of its rival and in solidarity against Israel. Fatah likely chose not to interfere with the West Bank protests to avoid aggravating matters, but it cannot allow the protests to spiral out of control.
Fatah is hoping that Hamas and Israel reach a truce as soon as possible. Indeed, the West Bank group is likely using its channels with the United States and Israel toward this end. Clearly, Fatah does not want protests in the West Bank to go from supporting Hamas and Gaza to turning against mismanagement in the West Bank. At the same time, this could be a reason why Hamas, which seeks a resurgence in the West Bank, would want to prolong the conflict somewhat.
The stirring of turmoil in the West Bank is very worrisome for Jordan, which neighbors the Palestinian territory and is home to a large population of Palestinian heritage that harbors anti-Israeli sentiments. The ruling Hashemites do not want to see the Gaza issue spill over Jordan's borders and accentuate their own problems.
The effects of the Arab Spring have not really manifested themselves in Jordan, but the kingdom has not been stable either. Since the outbreak of the regional unrest in early 2011, King Abdullah II has replaced three prime ministers in response to low-level but steady protests. The dilemma that the Hashemites face is that unrest has spread into the ranks of the tribal forces (aka East Bankers), who until recently have served as the bedrock of the monarchy's stability. At the same time, in urban areas, the country's largest political movement, the Muslim Brotherhood, has departed from its traditional role as the loyal opposition and begun demanding that the palace share power with parliament.
Meanwhile, the economic situation in the country has deteriorated to the extent that the government was forced to cut fuel subsidies earlier this month. The public backlash to the rising energy costs has intensified the protests. In the early months of the Arab Spring, there were isolated cases of tribal youths chanting slogans against the Jordanian king and queen. Such instances of public criticism -- some even calling for the king to step down -- appear to be growing.
Still, neither the rural-based tribal principals nor the urban-centered Brotherhood appear to be interested in trying to topple the monarchy. Indeed, both have made it clear that they do not wish to see unrest turn into anarchy. But the problem is that neither institution seems to have a monopoly over the protests; youth groups and other non-brand entities are driving some of the agitation.
The Brotherhood, which has long called for the kingdom to cut ties with Israel, has once again raised this demand. Such calls have not gained traction in the past. But in the post-Arab Spring atmosphere -- and now with the conflict in Gaza -- the demand could become a tool for the Brotherhood to extract even greater concessions from the palace. Already, the king has been on the defensive, asking the Brotherhood to end its boycott of the political system and participate in upcoming parliamentary polls. Moreover, after restoring ties with Hamas earlier this year, the king has sought the mediation of Hamas chief Khaled Meshaal toward this end.
It is too early to tell what domestic political gains the Brotherhood could obtain by leveraging the fighting in Gaza. But the king's persistently defensive approach could lead to apprehension within his camp about whether he has what it takes to steer the country out of its downward spiral. Any fissures within the ranks of the Hashemite state will lead only to greater instability. Over the longer term, instability in Jordan breeds the same in the West Bank, where the ruling Palestinian National Authority has been unable to resolve its own political problems.
8 - Geo-Political Event
GEO-POLITICAL - Israel, Egypt and the Gaza Strip
Israel Defense Forces confirmed Nov. 14 that it had killed Ahmed Jabari, the leader of Hamas' armed wing, the Izz al-Deen al-Qassam Brigades. The airstrike that killed Jabari came a day after Israel warned that it was considering targeted assassinations in response to increasing rocket fire from Gaza. In addition to the strike on Jabari, the Israeli air force reportedly attacked a cache of 20 long-range missiles and a Gaza police station, and loud explosions are being reported in Gaza City. An IDF spokesman announced that the Israeli military was embarking on Operation Pillar of Defense, which could include a ground incursion into Gaza. The assassination of Jabari seems to have been a first salvo, one that will provoke retaliation from Hamas and that could affect Jordan and Syria. Renewed and expanded bouts of rocket fire are certain, including rockets targeting urban areas. But the question is what other operations Hamas can and will conduct. Stratfor
It was widely reported that Israel agreed to delay any war against Iran until after U.S. elections. A little over a week after the election, Israel launched a "targeted assassination" against the leader of Hamas (who Haaretz called Israel's subcontractor in Gaza). That is what started the current round of fighting.
Professor Michel Chossudovsky notes: On November 14, Hamas military commander Ahmed Jabari was murdered in a Israeli missile attack. In a bitter irony, barely a few hours before the attack, Hamas received the draft proposal of a permanent truce agreement with Israel.
The targeted assassination of Ahmed Jabari was followed by an extensive bombing campaign under Operation Pillar of Cloud. The latter consists of a carefully planned military endeavor.
Leading German newspaper Spiegel reports: Israeli Prime Minister Benjamin Netanyahu is hoping the offensive in the Gaza Strip wins his Likud party more votes in January’s election. “When the cannons roar, we see only Netanyahu and Barak on the screen, and all the other politicians have to applaud them,” wrote the daily Haaretz in a commentary published Thursday. “The assassination of (Hamas’ top military commander Ahmed) Jabari will go down in history as another showy military action initiated by an outgoing government on the eve of an election.”
Asia times writes: So why snuff out al-Jabari? Simple. Israel goes to the polls in January. Thus emerges Bibi's political campaigning in full-action mode. Campaign motto: Let's kill Palestinians. With such thrills on offer, any other Israeli political voice - even slightly dissenting - is drowned.
This escalation occurs just days after widespread reports about newly reelected Obama mulling a grand bargain with Iran over its disputed nuclear program. Barbara Slavin and Laura Rozen at Al-Monitor reported on Monday that US officials told them Washington was considering offering a “more for more” deal with Iran, based on the fuel swap deal from Obama’s first term.
So what does Israel’s impending war on defenseless Gaza have to do with Iran diplomacy? Here’s a tweet from the Tehran bureau chief for the New York Times, Thomas Erdbrink:
Forget ANY #Iran-US talks if conflict in Gaza escalates
I suspect this point was not lost on the Israeli leadership, either. So, is Netanyahu knowingly escalating military tensions in order to avoid a successful diplomatic overture? I’m speculating, but it isn’t far fetched. We know from extensive reporting, mainly in Israeli media, that in 2010 – just as President Obama requested a freeze on Jewish settlements in the West Bank with the aim of resuming peace talks – Israeli Prime Minister Benjamin Netanyahu tried to provoke Iran into a war with Israel that would eventually drag in the United States.
It reminds me of what former CIA Middle East analyst Paul Pillar referred to this week as “Netanyahu’s tension-stoking brinksmanship: to divert attention from continued Israeli occupation of Palestinian territory and inaction on the festering Israeli-Palestinian conflict.” “[T]he Iran issue,” Pillar has previously written, provides a “distraction” from international “attention to the Palestinians’ lack of popular sovereignty.” Now the situation seems reversed: Israel is escalating war with Gaza to maintain deadlock with their favorite scapegoat, Iran.
Israel, lest we forget, instigated this resumption of missile exchanges last week when two Palestinian civilians were shot and killed and
Israeli tanks intruded into Gaza, prompting Gaza militants to respond by targeting Israeli soldiers, which then gave Israel an excuse to unleash successive airstrikes. And Israel had numerous chances to pacify the situation, considering Hamas publicly offered to establish a total ceasefire and Egypt appeared about to broker a truce between the two. Israel has intentionally inched towards escalation from the beginning. Are we to believe this isn’t strategic?
THEORY 2 - A second theory is that this is a prelude to an Israeli attack on Iran. Specifically, some theorize that Israeli is trying to assassinate top Hamas militants before hitting Iran … so that Iran’s proxy Hamas cannot retaliate.
THEORY 3 - A third theory is that Israel is trying to drag Iran into a war. Given that Israeli treatment of Palestinians is perhaps the key source of hostility towards the current Israeli administration in the Arab world, starting a war in Gaza may be an attempt by Israeli to drag Iran into war.
After all, Iran backs Hamas, and Israel just assassinated a top Hamas leader after making an overture of peace to him. So some believe that Israel is attempting to poke the hornet’s nest in an attempt to justify wider war. By provoking Hamas into attacking, Israel might point to Hamas-backer Iran. Specifically, Israel may claim that pre-emptive strikes on Iran are "necessary" to undermine Hamas and make sure it doesn't obtain "weapons of mass destruction".
The always prescient NAHB index reached levels not seen since May 2006 this morning completing its sixth beat out of the last seven with its biggest jump since July (a five-sigma beat of expectation no less!). Driven by a huge 8 point jump in 'present' sales (an all-time record 13-month rise?) and a rise in the outlook driven by a huge jump in Midwest expectations. We can only look on with incredulity that this index is given any credibility at all. Perhaps a longer-term look at the index is useful to realize that while we have risen, we are merely at the 9/11/01 trough levels - as always context is king.
NAHB Index rises to May 06 levels...
The Present Sales index has risen its most ever in the last 13-months - historically this kind of epic rise in the index has capped further gains for 3-6 months...
led by Midwest Present Sales... which are back near the highs of 2005!!!
Consensus is for existing home sales to fall to an annualized pace of 4.7 million and for the housing market index to rise to 42.
Homebuilder Sentiment jumped to its highest level since 2006, hitting a reading of 46. This is potentially a big deal. On Twitter, @pawelmorski reprises this chart from DB's Torsten Slok, comparing NAHB homebuilder sentiment with Residential Construction's contribution to GDP (with a 12-month lag). Given the surge in sentiment, if the pattern continues, espect to see homebuilding make a monster contribution to the economy.
12 - Residential Real Estate - Phase II
HOUSING - Potential Increase in Household Formations due to "Headship" Surge
It's actually astonishing how much new housing starts can add to the economy.
Says Deutsche Bank's Joe Lavogna, in regards to homebuilding...
The year-to-date contribution to real GDP has been 30 bps per quarter. This should increase to 60 bps per quarter next year given the scenario highlighted above. Additionally, higher consumption of housing-related services coupled with the indirect effects from home price appreciation (i.e., wealth effects) could easily raise the housing contribution to one full percentage point. In short, housing could provide a meaningful (and critical) lift to overall economic activity at a time when other growth drivers, like exports, are slowing.
It's great that homebuilding has the potential to add 1 full percentage point per quarter, but what will keep homebuilding going?
In a recent note, Goldman economists Hui Shan, Sven Jari Stehn, and Jan Hatzius explained the forces that will drive increasing household starts/homebuilding for the next few years.
Recent housing market data have been encouraging. Household formation has started to rebound from its post-crisis lows and housing starts have shown notable gains in recent months, surging by 15% in September alone. In light of these encouraging developments, we revisit the homebuilding outlook in today’s comment.
First, we update our model of household formation, which combines projections of the headship rate—defined as the percent of people who are heads of households—with Census population projections. Our analysis suggests that annual household formation will increase from its current 1.0 million rate to 1.2 million in 2013 and 1.3 million in 2014-2016. The improvement in expected household formation is driven by an increasing headship rate among the young, population growth, and the aging population.
Second, we use our household formation projections to forecast housing starts in two steps. We first estimate excess housing supply based on a long-run relationship between the number of houses and the number of households. We then link the estimated excess housing supply to housing starts. Our analysis implies that annual housing starts will increase to 1.0 million by the end of 2013 and 1.5 million by the end of 2016.
For those not familiar with the term "headship rate" it basically just means the rate at which individuals become heads of households, something that dropped precipitously during the crisis, as more and more young people lived at home, and immigrants stayed away.
This chart shows how headship rate among 25-34 year olds really collapsed during the crisis, but is now rebounding back towards pre-crisis trends. Goldman expects the direction to keep going up.
Here are Goldman's headship projections:
So ultimately, consistent with growing headship rates among the 18-34 demographic (and only slowly declining rates among the others) Goldman sees a solid basis for more household formation and more starts.
The potential to add to GDP is significant.
12 - Residential Real Estate - Phase II
AMERICAN HERO: Ron Paul's Congressional Farewell Speech
On Wednesday, Rep. Ron Paul (R-Texas) delivered a 48-minute farewell address on the House floor after serving 30 years in Congress. His farewell speech is arguably the best in his career.
Time permitting, I strongly encourage everyone to play the video or at least read the full and complete text. For now ...
Here are a few highlights.
Note: For ease in reading, I dispense with my normal blockquotes (indentation).
The major stumbling block to real change in Washington is the total resistance to admitting that the country is broke. This has made compromising, just to agree to increase spending, inevitable since neither side has any intention of cutting spending.
If liberty is what we claim it is- the principle that protects all personal, social and economic decisions necessary for maximum prosperity and the best chance for peace- it should be an easy sell. Yet, history has shown that the masses have been quite receptive to the promises of authoritarians which are rarely if ever fulfilled.
In the early part of the 20th century our politicians promoted the notion that the tax and monetary systems had to change if we were to involve ourselves in excessive domestic and military spending. That is why Congress gave us the Federal Reserve and the income tax. The majority of Americans and many government officials agreed that sacrificing some liberty was necessary to carry out what some claimed to be “progressive” ideas. They failed to recognized that what they were doing was exactly opposite of what the colonists were seeking when they broke away from the British.
We Need an Intellectual Awakening. Without an intellectual awakening, the turning point will be driven by economic law. A dollar crisis will bring the current out-of-control system to its knees.
If it’s not accepted that big government, fiat money, ignoring liberty, central economic planning, welfarism, and warfarism caused our crisis we can expect a continuous and dangerous march toward corporatism and even fascism with even more loss of our liberties. Prosperity for a large middle class though will become an abstract dream.
Economic ignorance is commonplace. Keynesianism continues to thrive, although today it is facing healthy and enthusiastic rebuttals. Believers in military Keynesianism and domestic Keynesianism continue to desperately promote their failed policies, as the economy languishes in a deep slumber.
The immoral use of force is the source of man’s political problems. Sadly, many religious groups, secular organizations, and psychopathic authoritarians endorse government initiated force to change the world. Even when the desired goals are well-intentioned—or especially when well-intentioned—the results are dismal.
We now have a standing army of armed bureaucrats in the TSA, CIA, FBI, Fish and Wildlife, FEMA, IRS, Corp of Engineers, etc. numbering over 100,000. Citizens are guilty until proven innocent in the unconstitutional administrative courts.
Government in a free society should have no authority to meddle in social activities or the economic transactions of individuals. Nor should government meddle in the affairs of other nations. All things peaceful, even when controversial, should be permitted.
The Constitution established four federal crimes. Today the experts can’t even agree on how many federal crimes are now on the books—they number into the thousands. No one person can comprehend the enormity of the legal system—especially the tax code. Due to the ill-advised drug war and the endless federal expansion of the criminal code we have over 6 million people under correctional suspension, more than the Soviets ever had, and more than any other nation today, including China. I don’t understand the complacency of the Congress and the willingness to continue their obsession with passing more Federal laws. Mandatory sentencing laws associated with drug laws have compounded our prison problems.
The federal register is now 75,000 pages long and the tax code has 72,000 pages, and expands every year. When will the people start shouting, “enough is enough,” and demand Congress cease and desist.
It is claimed that war, to prevent war for noble purposes, is justified. This is similar to what we were once told that: “destroying a village to save a village” was justified. It was said by a US Secretary of State that the loss of 500,000 Iraqis, mostly children, in the 1990s, as a result of American bombs and sanctions, was “worth it” to achieve the “good” we brought to the Iraqi people. And look at the mess that Iraq is in today.
Excessive government has created such a mess it prompts many questions:
Why are sick people who use medical marijuana put in prison?
Why can’t Americans manufacture rope and other products from hemp?
Why are Americans not allowed to use gold and silver as legal tender as mandated by the Constitution?
Why do our political leaders believe it’s unnecessary to thoroughly audit our own gold?
Why can’t Americans decide which type of light bulbs they can buy?
Why is the TSA permitted to abuse the rights of any American traveling by air?
Why should there be mandatory sentences—even up to life for crimes without victims—as our drug laws require?
Why haven’t we given up on the drug war since it’s an obvious failure and violates the people’s rights? Has nobody noticed that the authorities can’t even keep drugs out of the prisons? How can making our entire society a prison solve the problem?
Why do we sacrifice so much getting needlessly involved in border disputes and civil strife around the world and ignore the root cause of the most deadly border in the world -the one between Mexico and the US?
Why does Congress willingly give up its prerogatives to the Executive Branch?
Why does changing the party in power never change policy? Could it be that the views of both parties are essentially the same?
Why did the big banks, the large corporations, and foreign banks and foreign central banks get bailed out in 2008 and the middle class lost their jobs and their homes?
Why do so many in the government and the federal officials believe that creating money out of thin air creates wealth?
Why do so many accept the deeply flawed principle that government bureaucrats and politicians can protect us from ourselves without totally destroying the principle of liberty?
Why can’t people understand that war always destroys wealth and liberty?
Why is there so little concern for the Executive Order that gives the President authority to establish a “kill list,” including American citizens, of those targeted for assassination?
Why is patriotism thought to be blind loyalty to the government and the politicians who run it, rather than loyalty to the principles of liberty and support for the people? Real patriotism is a willingness to challenge the government when it’s wrong.
Why is it is claimed that if people won’t or can’t take care of their own needs, that people in government can do it for them?
Why do some members defend free markets, but not civil liberties?
Why do some members defend civil liberties but not free markets? Aren’t they the same?
Why don’t more defend both economic liberty and personal liberty?
Why does the use of religion to support a social gospel and preemptive wars, both of which requires authoritarians to use violence, or the threat of violence, go unchallenged? Aggression and forced redistribution of wealth has nothing to do with the teachings of the world’s great religions.
Why do we allow the government and the Federal Reserve to disseminate false information dealing with both economic and foreign policy?
Why should anyone be surprised that Congress has no credibility, since there’s such a disconnect between what politicians say and what they do?
What are the greatest dangers that the American people face today and impede the goal of a free society? There are five.
1. The continuous attack on our civil liberties which threatens the rule of law and our ability to resist the onrush of tyranny.
2. Violent anti-Americanism that has engulfed the world. Because the phenomenon of “blow-back” is not understood or denied, our foreign policy is destined to keep us involved in many wars that we have no business being in. National bankruptcy and a greater threat to our national security will result.
3. The ease in which we go to war, without a declaration by Congress, but accepting international authority from the UN or NATO even for preemptive wars, otherwise known as aggression.
4. A financial political crisis as a consequence of excessive debt, unfunded liabilities, spending, bailouts, and gross discrepancy in wealth distribution going from the middle class to the rich. The danger of central economic planning, by the Federal Reserve must be understood.
5. World government taking over local and US sovereignty by getting involved in the issues of war, welfare, trade, banking, a world currency, taxes, property ownership, and private ownership of guns.
The problem we have faced over the years has been that economic interventionists are swayed by envy, whereas social interventionists are swayed by intolerance of habits and lifestyles. The misunderstanding that tolerance is an endorsement of certain activities, motivates many to legislate moral standards which should only be set by individuals making their own choices. Both sides use force to deal with these misplaced emotions. Both are authoritarians. Neither endorses voluntarism. Both views ought to be rejected.
I have come to one firm conviction after these many years of trying to figure out “the plain truth of things.” The best chance for achieving peace and prosperity, for the maximum number of people world-wide, is to pursue the cause of LIBERTY.
If you find this to be a worthwhile message, spread it throughout the land. End Paul - Start Mish
It sounds so logical, doesn't it? So why are we in this mess?
The answer is we nominate clowns like Mitt Romney and President Obama and the vast majority of people choose between Tweedle-Dum and Tweedle-Dee based on some sense of morality orperhaps some kind of handout.
The pro-life hypocrites were willing to vote from Mitt Romney who is hell bent on starting a war with Iran in spite of obvious failures in Iraq and Afghanistan, in spite of the fact that war kills real living people.
As Paul said, "500,000 Iraqis, mostly children, in the 1990s died, as a result of American bombs and sanctions." Supposedly it was “worth it” for the greater “good”. It was so "worth it" that we did it a second time, and lied to do it.
Congressional lemmings supported the war en masse. Paul didn't. Neither did I, and I am proud of it. Question of the Day
If Republicans are not in favor of deficit spending and Democrats are not either, then how the Hell do we have trillion dollar deficits?
The answer is vast majority of politicians are liars, with no backbone to stand up and tell the truth to US citizens: "the country is broke".
We cannot afford wars. We cannot afford to keep troops in 140 countries. We cannot afford to be the world's policeman.
We also cannot afford Davis-Bacon and prevailing wage laws. We cannot afford the pension promises we have made. We cannot afford collective bargaining of public unions. We cannot afford all kinds of entitlements that have been promised.
How Does It Happen?
We have all of these things because corrupt politicians buy votes of constituents who want to hear the lie that we can afford those things. In the end, that's what it's really all about.
The unions, the warmongers, the banks, and all the other special interest groups buy votes of corrupt politicians every step of the way. The "compromise" in Congress is Republican get their wars and Democrats get fiscally unsound social programs.
In the meantime, government grows bigger and bigger and bigger. And the Fed (and Congress) repeatedly bail out the banks and the wealthy at the expense of the middle class.
A shockingly low 30% of S&P 500 firms beat revenue expectations in the prior quarter and while Bloomberg's data suggests around 65% beat earnings expectations, the in-period adjustment of expectations (analysts ratcheting down earnings as the season progresses) naturally biases this to look rosier. The critical question is - how much more fat is there to cut? With Sales (and outlooks) so weak, how many more jobs need to be cut to meet margin expectations? 2013 top- and bottom-line (+13.6% EPS growth) expectations remain magnificent in their optimism - do you believe in miracles?
Chart: Bloomberg Chart of the Day
17 - Shrinking Revenue Growth Rate
GLOBAL CONSUMER CONFIDENCE - Consolidated Highlights
North America’s consumer confidence index increased three points to 91 in Q3, driven by a rise of five points in Canada to a score of 99 and three points in the U.S. to a score of 90. While confidence in the U.S. job market (36%) still remained below the global average of 45 percent in Q3, there was no decline from the previous quarter. U.S. optimism for personal finances (53%) and immediate purchasing sentiment (35%) increased two percentage points each in Q3.
“The U.S. rise of three index points to 90 follows a five-point decline reported in Q2 and a nine-point rise in Q1, which reflects the uncertain nature of consumers and their spending patterns,” said James Russo, vice president, Global Consumer Insights, Nielsen. “While the latest sentiment is moving positively due to marginally improved labor market conditions, a housing market that is emerging from a five-year slump and tepid equity market gains, consumers continue to stretch budgets due to inflation-related purchases such as gasoline prices. With confidence results off pre-recession levels of 100+, expect the new normal to reflect continued spending restraint. Marketers will need to work harder to gain share of wallet and mind during critical Q4 spending as consumers continue to weigh purchases carefully as they redefine what value means to them.”
“A good sign for the U.S. recovering economy is the fact that, contrary to 2008, where non-discretionary food purchases dominated sales, consumerpackaged goods category unit growth is strongest among discretionary edible and non-edible categories,” said Todd Hale, senior vice president, Consumer & Shopper Insights, Nielsen U.S. “Winning edible categories include coolers, liquor, coffee, wine, tea and bottled water. The list of winning non-edible categories was led by canning and freezing supplies, women’s fragrances, cosmetics, and vitamins.”
“Canadians are feeling more confident about their personal balance sheets,” said Carman Allison, director, Consumer Insights, Nielsen Canada. “Despite the threat of rising prices, the current level of inflation remains consumer friendly, increasing 1.2 percent in the recent quarter. A healthy employment market with continued job creation and a rise in hourly earnings (up 3.8%) ahead of inflation has increased consumer spending power. In addition, the Canadian dollar has performed well in the past quarter, fluctuating around par or higher than the U.S. dollar. Canadians are flexing their growing spending power with shopping trips to the U.S. increasing 29 percent in the past year.”
“As key global economic indicators deteriorated last quarter, consumers remained uncertain and reticent to spend.”
Among 29 European countries measured, 17 reported the bottom 20 consumer confidence index scores of 58 countries in Q3. More than 90 percent of respondents in Italy, Portugal, Croatia, Spain, Ireland and Greece believed their countries were mired in recession. The debt crisis in austerity-stricken Southern Europe has brought record high unemployment and inflation to the region.
“In Italy, concerns about job security continue to increase as well as the percentage of households that would like to save after basic spending needs are fulfilled,” said Roberto Pedretti, managing director, Watch & Buy, Nielsen Italy. “Households continue to cut volumes, buying only essential goods in order to compensate for rising prices and to stabilize spending. From January 2012 to August 2012 hypermarkets, supermarkets and small markets registered a two percent decrease in sales volume and 0.2 percent increase in sales value.”
Conversely, Western Europe reported some of the highest consumer confidence index scores in the region. Switzerland’s index of 104 increased 10 points from Q2, which was among the top 10 highest scores of 58 countries measured. Belgium (88) increased nine index points and Norway (102) increased seven index points.
“In Switzerland, the government and Swiss National Bank have taken tough actions, especially to defend the currency exchange,” said Andreas Leisi, Market Leader, Nielsen Alpine. “Consumer price indexes on many categories such as food and autos are decreasing because of cross border shopping opportunity pressures, allowing consumers to buy more for their money.”
Germany reported a consumer confidence decline of two index points to a score of 86, behind Russia’s score of 87, which was flat from Q2. More consumers in Germany (58%) and Russia (64%) slipped back into a recessionary mindset in Q3, an increase of 14 and 10 percentage points, respectively.
“While consumer confidence in Germany declined two index points in Q3, the long-term view is still good,” said Mathias Bernhardt, Market Leader Buy, Nielsen Germany. “Nevertheless, there is an increasing risk that the ongoing Euro crisis may affect German consumer confidence. While spending intentions increased in the latest results providing a stabilizing factor for the economy, consumers’ growing fear of inflation is concerning.”
Eight of 14 Asia-Pacific countries measured reported a consumer confidence index score at or above the 100 benchmark and two countries were among the lowest scores in Q3. Reporting a consumer confidence index of 119, India held steady and Indonesia declined one index point, but both topped regional and global rankings. China’s index score of 106 was virtually flat, with a marginal increase of .6 from Q2. South Korea declined 10 points to an index of 40 and Japan’s score of 59 were among the lowest scores reported. Hong Kong suffered the biggest quarterly decline of 15 index points for a consumer confidence index of 89. Six in 10 Hong Kong respondents said they were in a recession, an increase of 19 percentage points from Q2.
“The Indian consumer appears to have reconciled with the challenges of the external environment and the economic climate,” said Piyush Mathur, president, Nielsen India. “In a typically resilient fashion, Indian consumers have adopted various strategies to counter inflation through a much keener effort to seek better deals at the point of sale and by timing bigger ticket purchases. Retailers and manufacturers too have realized that playing to these instincts are critical to succeeding in uncertain markets. ‘Dealweeks’ that offer deep discounts, special offers and bulk buying have helped consumers manage through a trying period.”
“As Nielsen’s latest Chinese Consumer Confidence data shows, while lower city tiers continue to drive growth, Tier 2 and Tier 3 cities are most affected by the export slowdown,” said Yan Xuan, president of Nielsen Greater China. “Tier 1 cities, which are making progress in re-orienting to a more service-based economy, seem to be better at insulating workers from some of the manufacturing woes. While we are not seeing a dramatic slowdown in consumer purchasing of fast-moving consumer goods, manufacturer shipments have slowed, which signals a potential weakening.”
“The extent of the Hong Kong consumer confidence decline is somewhat surprising given that property values are holding stable and near record highs,” said Oliver Rust, managing director, Nielsen Hong Kong. “However, a drop in China’s GDP, the escalating Euro debt crisis, and the U.S. presidential election are factors contributing to the uncertainty among Hong Kong consumers.”
Consumer confidence in Brazil climbed four index points in Q3 to 110 and maintained its ranking among the top 10 highest scores globally. The rise was driven by an increase in favorable job prospects, which grew three percentage points in Q3 to 69 percent. Additionally, 77 percent of Brazilians said their personal finances were good/excellent, which grew from 73 percent in the previous quarter. Fortythree percent of respondents indicated it was a good time to buy, which increased from 36 percent last quarter. Mexico’s consumer confidence score also increased three index points since last quarter to 84 and Chile held steady in Q3 at 94.
“The development of a strong internal market with stable inflation has been at the center of the efforts of the Brazilian Government for the last five years,” said Eduardo Ragasol, country manager, Nielsen Brazil. “While steady employment and expanded credit availability catapulted consumption to record highs in 2010 and 2011, increasing debts are slowing down consumption growth and new investments are needed to maintain positive momentum.”
Argentina dropped 11 index points in Q3 to a score of 75, the lowest in the region, driven by a 13 percentage point decline in favorable job prospects (28%) and a 10-point drop in respondents who indicated their personal finances were good/excellent (43%). Peru (97), Colombia (91) and Venezuela (82) also reported consumer confidence index declines in Q3.
“After a long period of sustained growth, the Argentina economy is beginning to show regressive indicators,” said Martha Lucia Giraldo, country manager, Nielsen Argentina. “Factors impacting consumption include rising prices, a reduction in labor demand and exchange constraints that seek to replace imported products with domestic brands.”
Paying off debts and credit card loans was a priority among 38 percent of Latin American respondents—a rise from 34 percent in Q2 and 36 percent last year. Twenty-seven percent said they put spare cash into savings. Spending on new clothes (24%) and home improvements (17%) declined three and two percentage points, respectively.
MIDDLE EAST / AFRICA
Consumer confidence in the United Arab Emirates jumped six index points in Q3 to 114, the highest index in the region and the third highest score globally, followed closely by Saudi Arabia (113), which declined two index points. Egypt (103) and Pakistan (91) held steady with no change reported from the previous quarter.
“The six index point increase in UAE consumer sentiment is significant, as it comes on the heels of three consecutive quarters of stagnant confidence stretching from the second half of last year into the first quarter of 2012,” said Sevil Ermin, Regional Client Director, Nielsen UAE. “The current sense of optimism is largely driven by a spike in job prospects. Prior to the global economic downturn, UAE consumers had exhibited a markedly upbeat disposition, which was substantiated by solid economic performance and mirrored in ambitious government plans. Only three years after being at the center of global real estate woes, past experiences seem to be guiding its comeback. Although not fully rebounded, a noticeable real estate recovery coupled with solid indicators in the core activities of trade, tourism, logistics and transport is providing clear signals of the UAE’s resilience. The country’s growing reputation as a regional safe haven following 18 months of unrest in other Arab states has also contributed to this revival in confidence.”
Israel’s consumer confidence declined seven index points in Q3 to 84, driven by an 11 percentage point decline in favorable job prospects (37%) and an eight percentage point decline in good/excellent personal finances (46%). Two-thirds of respondents in Israel said they were Middle East / Africa largely held steady in a recession—an increase from 48 percent in Q2. South Africa’s consumer confidence index score edged up one point to 78.
“In Israel, the increasing fear of a potential war against Iran is the most significant factor for the seven point consumer confidence decline,” said Sagit Attar, client service director, Nielsen Israel. “However, other key reasons include the high and increasing cost of living, rising unemployment and a decelerating economy. Major fastmoving consumer goods manufacturers said they plan to raise prices in October, which is also impacting sentiment.”
33 - Public Sentiment & Confidence
BUSINESS SENTIMENT - Executives Report Deteriorating Economic Environment
Data contained in last week’s economic reports depict a deteriorating economic environment, one slouching toward recession. real-time indicators are trending lower, while classic consumer-related barometers are signaling an economic downturn. Comments made by several company executives support the moderation depicted in the statistics.
The Philadelphia Fed’s Aruoba-DieboldScotti (ADS) business conditions index is a high-frequency indicator designed to track business conditions in real time. Some of its underlying economic indicators (incomes excluding transfer payments, nonfarm payroll employment, industrial production, and manufacturing and trade sales) are the same as those used by the National Bureau of economic research in determing recessions.
The average value of the ADS index is zero; deviations from that average imply either strength (positive readings) or weakness (negative readings). As of Nov. 10 the ADS was minus 0.72, a definitively weak level. For comparison, the ADS was at minus 0.70 in January 2008, two months into the Great recession.
Meanwhile, the consumer sector of the economy, which comprises about 72 percent of all economic activity in the U.S., has deteriorated and is currently trending lower. The lack of desirable wage and salary growth – real disposable personal incomes were flat in September after a 0.3 percent decline in August – has forced consumers to rein in spending. Consumer revolving credit (credit card) contracted an annualized 4.1 percent in September.
C-suite executives at Wal-Mart, the world’s largest retailer, confirmed this lackluster activity. CEO Bill Simon said: “With average fuel prices up approximately 6 percent versus this time last year, some customers are consolidating their shopping trips.” Simon said store traffic was up only about 0.1 percent.
Rosalind Brewer, Wal-Mart’s Sam’s Club’s CEO noted that business members continue to experience economic pressure and uncertainty, which has led to slower growth in business member traffic. “We anticipate this softening could remain a headwind in the fourth quarter,” she added.
Industrial production of consumer goods – a critical barometer of business cycle turning points – fell 0.9 percent in October. Over the last 12 months the production of consumer goods has fallen 0.8 percent. A great deal of this decline was in the nondurable goods component, which fell 1.2 percent last month.
Retail Sales fell 0.3 percent during October, while those excluding motor vehicles and parts were unchanged. The largest declines were registered at building material and garden equipment supplies dealers (minus 1.9 percent) and non-store retailers, which include electronic, catalog, and broadcast/infomercials (minus 1.8 percent.) It isn’t clear what the influence of hurricane Sandy was in this report since anecdotal experiences suggest a surge in home supply stores sales.
Once adjusted for inflation, as estimated by the Federal reserve Bank of Philadelphia, retail sales fell 0.5 percent in the month to a year-over-year increase of a lowly 1.7 percent.
Hope - it appears - peaked at the start of the year in the US, following the global coordinated central bank pump which ramped it from lows to highs within a few months. All that hope - and then some - has now apparently faded. The General Business Conditions expected six months forward dropped to its lowest level since March 2009. What is perhaps worse, given the focus on jobs jobs jobs, is that for the first time since April 2009, the employment outlook for employment turned negative - suggesting firms are looking to reduce employees at the fastest rate in over three-and-a-half years. The hopium seems to have been depleted...
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