Monday, December 13, 2010

Economy & Market Week Ended 12/4/2010

Our article on the Irish bailout by the EU and the IMF and how it came about entitled "Ireland's Indentured Servitude" was republished by Credit Writedowns and then picked up by the Business Insider.  Here is the original  article with the fully embedded sources.  I am in the process of writing another piece on "Surviving the Euro" which deals directly with the structural problems of the eurozone, what needs to be done, and why it is not being done.  These two articles have eliminated a large amount of economic information from this commentary, but there is more to Europe and why we should be watching it as well as China.

We are seeing a replay of last Spring with sovereign debt problems in Europe and efforts by China to raise interest rates and tighten credit.  Both the European and Chinese stock markets have declined similarly.  To add to the similarity with last Spring, the U. S dollar is appreciating again.

The threat of crisis contagion in Europe's appears to be alive and well however costumed, but no political sweet talk and smoothing over seems to have averted eyes from Portugal and Spain.  In fact, government and corporate bond markets continued to sell off across Europe putting pressure on even core eurozone countries.  Even the German bunds became infected.  The failure of the EU and ECB to act in a timely fashion to support the eurozone countries struggling to maintain liquidity in the face of growing international uncertainty as to the willingness of the ECB and EMU to defend the euro in a credit crisis, particularly with Germany and France sandbagging a monetary union without a fiscal mechanism against an eventual tsunami rather than a flood.

While the ECB's Trichet, after the governing board met, tried to calm the market by saying the euro was credible and at first only hinting about buying bonds, which is a contentious issue in the eurozone, while in fact evidently buying Irish and Portuguese debt.  This only creates confusion and uncertainty internationally, while he is forced to play to the internal politics of eurozone member nations, which do not favor the shared costs of normal monetary crisis tools nor will they authorize the ECB to use the monetary tools normally available to a fiat currency central bank.

As Felix Salmon has argued, the problem with Ireland's banks is not artificial risk reduction or Basel capital requirements.  But the failure of Ireland to recognize the full extent of toxic assets on the books of the Irish banks and the extent of mismanagement at Anglo Irish Bank and to quickly strip them out led directly to an over investment in the Irish banks by the Irish government, when they inappropriately, but at the urging of the EU and ECB, made private bank debt public debt.  In turn, the ECB demanded a bailout when it felt the level of ECB and Central Bank of Ireland loans to the banks had reached a dangerous level without direct intervention.  This only increases the speculation that Greece, Ireland, Portugal are essentially insolvent and, as the credit and currency crisis spreads, other eurozone nations will follow.  Willem Buitler, chief economist at Citigroup, opined that not only Ireland, Greece, and Portugal insolvent but Spain will be also when the weaknesses of its banks are recognized as well as the potential threats of political instability and high debt levels in Belgium and Italy and the ESFS rescue fund needs to be much larger in the neighborhood of 2 trillion euro (about 4 times larger).  At the same time the eurozone's growth is slowing down to about 1.6%-1.5%for next year as austerity programs push deteriorating conditions.

Spain is expected to grow only .7% next year rather than the 1.3% the Spanish government is projecting and to continue to lose jobs.  Spain continues to assert its banks are healthy and they are on track in their austerity program, but they have also started to point the finger of blame for the current uncertainty at France and Germany.  Zapatero said that the eurozone needs a common economic and fiscal policy, which is true, but this is interpreted in Germany as more money Germany has to contribute to the monetary union from it has particularly benefited economically.  Some bank analysts are attributing Spanish banks seeking less ECB loans as an indication of a shrinking loan book and the use of market repo funding.  Spain's central bank has imposed more conservative regulations and pushed savings banks consolidations, but some of Spain's mid-sized banks remain vulnerable to interbank lending problems.  While the austerity program continues to damage Spain's economy, the government continues to push austerity, defend the strength of Spanish banks, and is pursuing sovereign wealth funds to invest in Spain.  The pressure on Spanish bond yields put pressure on Italian bond spreads also.  Italy, which has one of the larger economies as a G8 country, has recognized the danger and urged the ECB to buy Spanish and Portuguese bonds in order to protect its own bond spreads as Spain is the keystone in this credit and currency crisis to the core eurozone countries.  Given Italy's debt and large economy, the eurozone cannot afford the credit crisis to spread to Italy.

While Portugal is being pushed to tighten its budget and reduce debt and the report of the Central Bank of Portugal, which is pushing for more austerity, demonstrates how fiscal austerity does not work during a debt deleveraging cycle.  While Greece's austerity program and EU/IMF bailout is on track, the amount of debt to be repaid in 2014-15 (about 110 billion euro) is too large without either an extension or restructuring as I have said in the past.  S&P is weighing whether to downgrade Greece's long term debt if the bailout rules threaten private bond holders of Greek debt.

Germany continues to question and beat its head against the wall by claiming liquidity will not help the credit and currency crisis and risks putting too much money into the economy, despite German bank and insurance company exposure.  If Spain starts to wobble, Germany will have some very harsh realities to face.  Spain is a prisoner of the euro.  German banks are heavily invested in Spain and contributed to its real estate bubble.  The euro created a significant economic advantage to Germany in exporting to other eurozone countries as the result of the exchange rates established within the eurozone.  As such, the potential crisis brewing in Spain was made in Germany.  The policies of Germany today are similar to the policies which lead to the German currency crisis of 1931 and financial  failure which deepen the Great recession globally and the rise of right wing fascism.  Germany's opposition to a euro bond and a fiscal mechanism within the eurozone is based not only on its shared cost but internal politics within Germany where the word for debt also means shame.  The refusal to act in the common good to stimulate the economies of the eurozone and bring them into closer harmonization is only increasing the threat to German banks and, hence, to Germany itself and the unthinkable.  The Irish crisis is consequently a huge test for the eurozone.  When lowering fiscal deficits becomes the priority in minds it denies the stagnation of fiscal austerity excess and higher interest rates as opposed to fiscal retrenchment and economic investment stimulus with lower interest rates which inspire business and consumer confidence which includes, but is not dependent, on exports.  Fear of debt becomes suicidal.

China's leaders have decided to pursue a prudent monetary policy while maintaining a proactive fiscal policy in acknowledgment of a need to promote a quantitative tightening which will require a slow step by step process which will require assessing its positive and negative impacts on disparate sectors of the Chinese economy as hot cash inflows continue.  China has had an active monetary program to sterilize capital inflows and kept inflation down which has made approximately 25% of the money supply illiquid, which means China's money supply is actually smaller than it appears. It is controlling interest rates with the spread between lending and deposits of 3%. In order to reduce its foreign cash reserves from its trade surplus, it  buys U.S. Treasuries by selling U.S. dollars which appreciates the yuan while also helping the United States depreciate the U.S. dollar and maintain a low interest rate economy.  The relationship between the United States and China is very mutually beneficial as well as entangled.  On the first of December, China's leading indicator signaled a warning it may be ready for a stock market downturn and take commodities with it.

The financialization of commodities with derivatives and exchange traded (index) funds has created volatility in the market with more commodity price risk for index funds and increased correlation between stocks and commodities.  At the same time closet indexing by "actively" managed mutual funds brings down the average performance of those funds and of active mutual funds as a whole.

The IRS has issued guidance on in-plan Roth rollovers for qualified plans which have a Roth contribution program.

According to the Federal Reserve Beige (anecdotal) Report, the economy was showing slow improvement in most areas, although housing remains depressed and real estate and construction remains at low levels.

The ISM Manufacturing report showed new orders to inventories ratio going negative at only <.1>, but it is something which should be watched as it has a good track record of turning negative prior to economic downturns.

The employment report for the month of November was released and unemployment rose from 9.6% to 9.8% with only net increase of 39,000 jobs when 115,000 had been expected.  Discouraged workers remained unchanged at 17.0%.  If we still were using the 1980's calculation for determining discouraged workers, it would be approximately 23%. The participation rate remained flat at 64.5%, down from 64.7, indicating people are not rejoining the work force.  Unemployment remains cyclical and not structural, although there is a growing number of 24-35 year old unemployment, more male than female.  I maintain there is the possibility that unemployment for the overthe over 55 (maybe 50) may be structural because they have earned too much money in the past and age discrimination is rampant.  The NFIB small business survey will not be out until December 14th, but advance information indicates that employment picked up to .01 from .00.

In John Hussman's weekly commentary, 11/29/2010, he concentrated on financial reform, particularly referencing the work of Rudiger Dornbusch, who said when you have bad banks you clean them up or they go only one way --- worse.  Cleanings up bad banks is essential to achieving a well functioning economy.  He notes that banks reliance on short term deposits is worse than it was prior to the financial crisis with time deposits declining for seven straight months and the cost of funding assets has dropped below 1% as banks concentrate on the shortest possible liabilities in order to earn the highest interest spreads.  This indicates that, while the economy's monthly progress may be encouraging, the problem is just being kicked down the road.  While the economy is likely to expand 2.3% annually over the next four years, the output gap implies an expectation of 3.8% annually.  A 3.8% real GDP growth would imply a 1.9% growth in jobs or about 200,000 per month or 2.5 million per year when we have lost over 7.5 million jobs.  With respect to the austerity programs in Europe, he said, "Unfortunately, imposing austerity on a weak economy typically results in further economic weakness and a shortfall on the revenue side."  In the U.S., he points out that there is a difference between surface improvements and the latent problems of banks, which as a result of the suspension of the FASB mark-to-market rules and the large amount of mortgage toxic assets on their books, having balance sheets which investors cannot fairly assess the banks real financial condition.  With respect to the market, he notes that in recent weeks he has noticed "risk on" and "risk off" days in which entire classes of securities are treated as if they were a single object with "risk on" days advancing financials, cyclicals, commodities, and speculative issues while the dollar weakens and "risk off days declining with relative strength in in consumer, health, and high quality stocks while the dollar strengthens.

Tobin's Q Ratio indicates the stock market is overvalued by historical standards 49% by arithmetically adjusted methods and 62% by geometrically adjusted methods.

Market: No banks failed this week; the unofficial problem bank list is 919.
                      DOW/Volume                             NASDAQ/Volume
Mon:           <35.91>/up 115.6%                       <9.34>/up 170.5%
Tue:             <46.47>/up 64.9%                        <26.99>/up 30.7%
Wed:           249.76/down 26.7%                        51.20/down 7.9%
Thu:             106.63/up 0.3%                              29.92/down 3.1%
Fri:                19.68/down 18.9%                        12.11/down 11.2%

Total             293.69                                           56.90

Mon: Oil up $1.97 to $85.73; Dollar stronger; despite large volume, indexes were still below average volume; market is still worried about Europe's financial stability; market pared losses during the day; dollar stronger despite QE2 as the result of declining euro.

Tue: Oil down 1.62 to 84.11; Dollar weaker but stronger against the euro; volume above average; Google down on EU antitrust investigation of favoritism in its search rankings; euro at two month low; eurozone bond spreads swell.

Wed: Oil up 2.64 to 86.75; Dollar weaker but stronger against the yen; big surge on lower volume as the big money stays on the sidelines; economic news viewed as growth; oil supplies were up 1.1 million barrels, gas supplies were up 600,000 barrels, and distillate down 200,000 barrels; Europe calm on ECB & IMF bailout hopes for Ireland. 

Thu: Oil up 1.25 to 87.00; Dollar weaker but stronger against the pound; market ignores jobless claims and seizes on pending home sales being up; weekly jobless claims were up 26,000 to 436,000, 4 week moving average was down 5750 to 431,000, and continuing claims were up 53,000 to 4,270,000.

Fri: Oil up 1.19 to 89.19; Dollar weaker; market ignores horribly disappointing November jobs report; Dow ended higher after being down most of the day; Nasdaq reached a new high for year; some market analysts would consider this a confirmed market uptrend but I do not like small gains on down volume.

United States:  Bullard (St. Louis Fed President) expressed concern that the Consumer Financial Protection Bureau is funded by a fixed percentage of central bank expenses which may have no direct relationship to the functional needs of the Bureau.  What would happen if market conditions change?  The mission of the Bureau is significant and potentially broader than regulators current functions.  Interestingly enough, Congressional republicans are preparing to confront Elizabeth Warren who wants transparency and accountability in the financial sector and who has been charged with establishing and setting up the Bureau, by posing the Bureau as big government.

Hoenig (Kansas City Fed President) gave a speech in which he said the financial institutions have become bigger as the result of "too big to fail" subsidies and, as such, they have become too big to succeed and a version of Glass-Steagall needs to be enacted creating smaller and more competitive financial institutions which would not be systemically dangerous.  One economic paper has proposed a macroprudential tax on borrowing during boom times to fund a bailout mechanism as a means of capturing the external costs borrowers impose on society and reducing moral hazard by reducing the incentive to borrow when bailouts in systemic crises are assumed.

A Bank of America employee admitted under oath that it was routine for Bank of America to keep notes after they were sold.  One fact of the servicer driven foreclosure mess is that a significant number of foreclosures involve people who have made every single mortgage payment.  Is this the perfect crime?  It happens with servicer errors and fraud.

The SEC is reviewing SEC official's testimony before Congress for violations of federal law.

Economic disgust with President Obama's alliance with deficit hawks during a high unemployment slow and tenuous economic recovery which is vulnerable to economic shocks continues to grow as his statements and arguments are picked apart as he takes advice from people who have no competent understanding of economics and the type of stimulus needed in a balance sheet recession.  Tax cuts for the wealthy, which are being pushed by deficit hawks, will have little impact on unemployment and aggregate demand and will substantially increase the deficit.  The Bush tax cuts did not promote economic growth and Bush's economic advisers knew full well the cuts would yield a revenue loss.  Changes proposed for Social Security amount to the bottom line of workers will have to work longer because the rich are living longer.  An alternative to the Deficit Commission recommendations, which appear will not receive Commission enough votes to report to The President and Congress, has been published by a group in combination with the Economic Policy Institute, entitled "Investing in America's Economy" which at least is emphasizing the need for investment to stimulate the economy although it has little chance of a rational debate.

President Obama also proposed a Federal employee pay freeze for the next two years.

Yellin, Vice Chairman of the Fed, gave a speech on "Fiscal Responsibility and Global Rebalancing", in which she said the United States economy is different from emerging economies in that with low inflation and slow economic growth, the United States needs to focus on fiscal consolidation long term and concentrate on near term economic stimulus which will support recovery.  She said Fed policy is not a panacea for weak U.S. growth and would be more effective if combined with near term fiscal stimulus.

The Federal Reserve finally released information on who received $3.3 trillion in emergency lending during the financial crisis which showed that the largest U.S. and international banks received most of the money.  Despite the legal requirement under the Dodd-Frank bill, the Federal Reserve refused to release a list of collateral pledged by recipients of $885 billion.

State tax revenues increased 4.9% in Q3 and 2.6% up vs year age, although still 7% below two years ago, with only six states out of 48 not showing improvement.  Illinois sales tax revenue was only up 0.1%

Oil consumption is up 4.9% in September, which is the biggest yearly gain since June '04 and Q3 is up 4.1%, which is the highest demand since Q2 2008.

The ADP private employer survey showed an increase of 93,000 jobs in November (the November BLS report was only 39,000).

U.S. productivity was up 2.3% Q3 (expected 2.4%).

16.3% of consumers used credit cards over Black Friday weekend vs 30.9% last year.

The Case-Schiller 20 city house prices were down 2.0% September (July-September) Q3, after being up 4.7% in Q2.  The expected housing decline has begun in earnest.

Vehicle miles driven were up 1.5% September vs year ago with 3.7 billion miles driven.

Dallas fed manufacturing survey showed production index up November to 13 from 7; new orders up to 9.1 from <4.3> --- first month positive in six months; capacity utilization was up to 9.9 from <2.3>.

Bond mutual funds had $4.33 billion outflows last week for the first time since December 17, 2008.

Consumer bankruptcy filings were down 13.3% in November to a 9 month low.

Worker productivity was up to 2.3% annualized Q3.

GM is carrying $30 billion in Goodwill on its balance sheet and all GM IPO proceeds will go to pay U.S. Treasury and pension funds as well as $2 billion from cash.  Its Q3 SEC filing said disclosure controls and procedures and internal controls were not effective and could materially adversely effect financial condition.

Chicago PMI (Purchasing Manager's Index - wholesale prices) was up to 62,5 in November from 60.6, which was more than expected.

The ISM manufacturing index  was down to 56.6 in November from 56.9; new orders were down to 56.6 from 58.9.

PC sales estimate was cut to 14.3% for year from 17.9% (September) with 2011 sales estimates revised down from 18.1% to 15.9%.

GM vehicle sales were up 21% in November vs year ago; Ford was up 24% excluding Volvo sale; Chrysler was up 16.7%; Toyota was down approximately 3%.

Big Lots Q3 EPS was down 15% while sales were up 2%.  They said they were hurt by strong discount competition and rising credit and processing fees.

Pending home sales were up 10.4% to 8% (expected 0.5% down).

The ISM service index was up to 55 in November from 54.3.

Retail November same store sales were up 5.3%.

Foreclosure sales were down 25% Q3 vs Q2.


U.S. manufacturing new orders were down 0.9% in October for the first drop in 4 months (expected down 1.3%) on weak durable goods demand.

The ECRI WLI (Weekly Leading Indicators) was up to <2.4> from <3.3> the prior week.

International: France is joining Ireland and Hungary in tapping pension funds to pay debt.

European insurance companies are looking at buying 1 billion euro of distressed debts from Irish banks.

Canada's economic growth slowed to 1% in Q3 from 2.3% in Q2 despite corporate capital spending being up 19.2% vs year ago (expected 1.5%); blamed strong currency restraining exports and boosting imports, of which the import of equipment and machinery was up 6.3%.  Inventories were also up.

The United Kingdom's Chancellor of the Exchequer said the UK was vindicated in not adopting the euro.  The eurozone credit and currency crisis threatens the UK's recovery as it attempts to rebalance to a positive net trade and investment balance if the credit crisis boils over into the real economy and axes Continental demand.  When the government's austerity program flounders and if  its export projected recovery is not sufficient, it has no Plan B to stimulate the economy.  The UK recovery is the weakest since World War II according to their Office of Budget Responsibility, which is independent, due to the continued credit crunch and its austerity program.

Investor's were incensed at the UK Financial Services Authority (FSA) refusal to release the report on the Royal Bank of Scotland's (RBS) near collapse which exonerate senior RBS managers.

UK students are not only being asked to pay educational fees which are increasing approximately 300%, but to also pay a graduate tax.  This is causing demonstrations in protest.

European bank stresses have reached the highest levels since last June.

Putin is calling for more Russian and German cooperation in forming a Russian-EU free trade zone.  This is something to watch, because Germany needs new export markets and energy imports.  Russia has energy to export which it is not reluctant to use as an economic weapon and it wants into the EU market economically and to have more influence over NATO.  This would also be consistent with how Germany raised international tensions and uncertainty in 1931.  The Wikileaks cables disclosed a Spanish prosecutor was adamant he had evidence that the Russian government is thoroughly infiltrated if not controlled by Russian organized crime.

The Irish bailout will be 845 billion euro ($115 billion).

Greece will have until 2021 to repay its 110 billion euro bailout at 5.8% (up from 5.5%) as it got extension from 2015.

An Italian bond auction was weakly covered.

India's GDP was 8.9% September annualized (expected 8.3%).

Walmart is paying $2.3 billion for 51% of South Africa's Massmart.


Eurozone growth for 2011 is estimated to be 1.5% down from 1.7% (expected in 2010) with Germany's estimated to be 2.2% (2011) down from an expected 3.7% in 2010.

Eurozone Q3 GDP was up 0.4% not annualized vs Q2.

China's institutions spent 519 billion yuan ($78 billion) in October to absorb foreign exchange inflows, which were the third largest ever and almost double September.

China PMI was up to 55.2 in November from 54.7.

Japanese output was down 1.8% in October.

Eurozone unemployment was up 0.1% to 10.1%; down in France, up in Italy, and flat in Spain and Germany.

Australia Q3 GDP was up only 0.2% (1.1% Q2) below expectations of up 0.5% as the result of higher interest rates.

UK house prices were down0.3% in November.

Portugal 1 year debt sold at 5.28% vs 4.81% two weeks ago.

Thailand's central bank raised interest rates 25 bps to 2% to curb inflation.

German retail sales were up 2.3% in October, which was the best since January '08, but still down 0.7% vs year ago.

Youth unemployment in France was up 0.8% to 25% for ages 15-24 (European average is 20.1%) with overall unemployment at 9.7% (10.1% for EU).

Pepsico is trying to buying a majority stake of Wimm-Bill-Dann in Russia.

Eurozone's service sector PMI was up 2.1 November to 55.4 and October eurozone retail sales were up 0.5%.

Brazil raised bank reserves to curb inflation.

Spain moved up pension reforms, hiked tobacco taxes, and trimmed wind power subsidies to facilitate budget deficit reductions.

After Trichet (ECB) made no mention of plans to increase purchases of sovereign debt, the euro fell.

Germany, on Wednesday, struggled to sell its bonds.

The Spanish bond auction was well received.

The IMF urged China and Hong Kong to implement measures to rein in property bubbles disconnected from fundamentals by increasing real interest rates, higher carrying costs of ownership (property tax), and China should also broaden financial market development to alternative investment vehicles from housing.

China will invest $1.5 trillion over 5-7 years to transition from manufacturing cheap goods to high tech products.

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