Where Is The Global Economy Going?

Let's take a look at some economic data, which we have not previously posted, from last week and this week though today (5/3/2011).


U.S. Federal Reserve Texas Manufacturing Survey down to 8 from 24 the prior month.

Brazil is worried about 6.44% inflation through mid-April.

China tells (unofficial report) three largest banks to raise capital adequacy ration to 11.8% and fourth to raise it to 11.7%.

U.S. Case-Schiller (3 month average) 20 City Housing Price Index down 3.3% March.

U.S. Federal Reserve (Richmond) manufacturing survey down to 10 from 20 in prior month.

UK GDP Q1 2011 up 5 tenths of a percent.

U.S. durable goods new orders up 2.5% March (exp 2.0), ex transportation up 1.3%, capital goods non-defense new orders up 2.1%, inventory up 1.3%.

Eurozone banks tighten lending standards.

U.S. GDP Q1 up 1.8% (exp 1.9).

Spain unemployment up top 21.3%; March retail sales down 8.6% year on year, CPI up 3.5% EU harmonized April year on year, national CPI up to 3.8% (2.7% annualized).

Bank of Japan said economy likely fell into recession in March; Japanese industrial production down 15.3% March (earthquake/tsunami) vs February, consumer spending down 5%.

German unemployment down 37,000 to 2.97 million (lowest since June 2009) -- fear of wage demands.

Eurozone inflation up to 2.8% April vs year ago (March was 2.7%)

German retail sales down 2.1% in March, down 3.5% vs year ago on lower food and clothing purchases.

U.S. ECRI Weekly Leading Index down to 7.5% from 7.7%

U.S. Federal Reserve (Chicago) economic activity up to .26 march from .16 February but 3 month moving average down to .20 from .27.

U.S. ISM manufacturing index down to 60.4 April from 61.2, inventory up to 53.6 from 47.4, new orders down to 61.7 from 63.3, prices up to 85.5 from 85, exports up to 62.0 from 52.5, imports down 1.0 to 55.5, employment down 3 tenths to 62.7.  On the whole this is actually very mixed results and trending negative despite exports/imports.

Eurozone manufacturing growth up to 58 April from 57.5

India raised its interest rate 50 bps with the repo rate at 7.25% and from now on pegging the reverse repo at 1% below the repo to fight inflation; headline inflation nearly 9% in March, GDP Q1 estimated at 8.6%.

U.S. factory new orders up 3% (exp 1.9) March and February revised from <.1> to up 7 tenths, ex transportation up 2.6%, non-defense new orders up 4.1%.

Eurozone PPI March up 6.7% vs year ago -- fastest since September 2008 --- driven by energy input prices up 13% (up 31% vs year ago).

China April PMI manufacturing down to 52.9 from 53.4 (exp up to 53.9).

UK PMI manufacturing April down to 54.6 from 56.7 for a 7 month low.

Doug Short is showing charts for the Q ratio at 1.18 with a arithmetic mean of 67%, a geometric mean of 81%, and he is using the Vanguard Total Market ETF (VTI) to adjust the quarterly Flow of Funds report monthly.  This showing the market is significantly over valued.

John Hussman continues to find the market over valued and over bought:

It's clear that present conditions are among the most extreme in history. In fact, to capture instances other than today, 1987 and 2007, we have to broaden the criteria. The following are sufficient for purposes of discussion:

"1) Overvalued: Shiller P/E over 18 (presently, the multiple is over 24)

"2) Overbought: S&P 500 within 1% of its upper Bollinger band on a daily, weekly and monthly resolution (20 periods, upper band 2 standard deviations above the moving average), and S&P 500 at least 20% above its 52-week low.

"3) Overbullish: Investors Intelligence bullish sentiment at least 45% and bearish sentiment less than 25% (presently, we have 54.3% bulls and 18.5% bears).

"4) Rising yields: Yields on the 10-year Treasury and the Dow 30 Corporate Bond Average above their levels of 6 months earlier.

"I should note that while present conditions easily fit into the foregoing criteria, we generally use a somewhat less restrictive criteria to define an "overvalued, overbought, overbullish, rising-yields syndrome in practice, in order to capture a larger number of important but less extreme periods of risk. The foregoing set of conditions isn't observed often, but the historical instances satisfying these criteria in post-war data are instructive. Here an exhaustive list of them:

"August 1972, November-December 1972: The S&P 500 quickly retreated about 5% from its August peak, then advanced again into to its bull market peak near year-end (about 6% above the August peak). The Dow then toppled -12.3% over the next 50 trading days, and collapsed to half its value over the following 22 months.

"August 1987: The market advanced about 6% from its initial signal into late August. The S&P 500 then lost a third of its value within 8 weeks.

"June 1997: The only mixed outcome, during the strongest segment of the late 1990's tech bubble. The S&P 500 advanced another 10% over the following 8 weeks, surrendered 4%, followed with a strong advance for several months, surrendered it during the 1998 Asian crisis, and then reasserted the bubble advance. Over a 5-year period, the overvaluation ultimately took its toll, as the the S&P 500 would eventually trade 10% below its June 1997 level by the end of the 2000-2002 bear market. Still, the emergence of the internet, booming capital spending, strong economic growth and job creation, rapidly falling inflation, and dot-com enthusiasm evidently combined to overwhelm the negative short- and intermediate-term implications of this signal.

"July 1999: The S&P 500 advanced by 3% over the next two weeks, then declined by about 12% through mid-October, and after a recovery to the March 2000 bull market high, the S&P 500 fell far below its July 1999 level by 2002.

"March 2000: The peak of the bubble - the S&P 500 lost 11% over the following three weeks, recovered much of that initial loss by September, and then lost half its value by October 2002.

"May/June 2007, July 2007: The S&P 500 gained 1% from the late-May/early-June signal to the July signal, then lost about 10% through August 2007, recovered to a marginal new high of 1565.15 by October (about 1% beyond the August peak), and then lost well over half of its value into the March 2009 low.

"February 2011, April 2011: A cluster of signals in the 2-week period between February 8-22 immediately followed by a decline of about 7% over the next 3 weeks. As of Friday, the market has recovered to a marginal new high about 1.5% above the February peak.

"So not including the cluster of signals we've observed in recent months, we've seen 6 clusters of instances in post-war data (we're taking the 1997, 1999 and 2000 cases as separate events since they were more than a few months apart). Four of them closely preceded the four worst market losses in post-war data, one was quickly followed by a 12% market decline, and one was a false signal over the short- and intermediate-term, yet the S&P 500 was still trading at a lower level 5 years later. The red bars indicate instances of this syndrome since 1970, plotted over the S&P 500 (log-scale).

"Examining this set of instances, it's clear that overvalued, overbought, overbullish, rising-yields syndromes as extreme as we observe today are even more important for their extended implications than they are for market prospects over say, 3-6 months. Though there is a tendency toward abrupt market plunges, the initial market losses in 1972 and 2007 were recovered over a period of several months before second signal emerged, followed by a major market decline. Despite the variability in short-term outcomes, and even the tendency for the market to advance by several percent after the syndrome emerges, the overall implications are clearly negative on the basis of average return/risk outcomes" 

Jeremy Grantham, in his quarterly letter, believes the world is at a paradigm shift in which we having a growing population with less available land and commodity prices have been going up. However, he expects commodities may go down in the next year and, if China stumbles economically (1 in 4 chance) and/or the weather is better than expected (80% probability), they may collapse causing a global crisis.  Given that we have been seeing droughts and catastrophes, it is very possible the overall weather will be better going forward.  In his view, abundant resources and falling prices are a concept of the past.  Energy and finite natural resources will have great difficulty meeting future demands without significant technological changes.

We have already written about copper, gold, and silver, but you can see possible problems with corn, wheat, cotton, cocoa, coffee, etc in the current market despite year to date returns.

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Inflation & Economic Recovery: Is It Time to Sell Gold and Silver?

I wrote in my recent article  about the confusion of core inflation and headline inflation which exists in many minds.  David Andolfatto, who is a Canadian economist who works for the St. Louis Federal Reserve, has written an explanatory piece on how the measurement of inflation is meant to have practical policy meaning and, if the purpose of core inflation is to approximate a trend, then why not calculate an inflation trend.  He shows how a trend line of inflation would look compared to headline and core:

 

At the same time, as my article Bernanke's press briefing indicated, the Fed appears to be overly concerned with inflation expectations as opposed to actual inflation.  Tom Duy believes the Fed will end QE2 and begin tightening to fight an inflation that does not appear to exist in reality given poor retail final sales, a very depressing continuing output gap in a "recovery", and slow GDP growth reflective of stagnating employment.  Tom Duy compares the 1982 recession recovery retail final sales chart with the current recovery retail final sales current figures chart showing the current recovery is pitiful in comparison.  He also shows in graph form that inflation is well contained.

The Australian economist Bill Mitchell continues his criticism of American economic policy with asinine public debate on the need to raise the debt ceiling, citing even Warren Buffet as stating that is the failure to raise the debt limit would be the most "asinine act" and that there should not be a debt limit in the first place.  Mitchell then looks at the slow U.S. GDP growth, continuing high unemployment, and continuing low inflation and finds the U. S. government's failure to provide sufficient economic stimulus in the form of fiscal spending to increase employment economically inappropriate and unconscionable.

David Andolfatto wrote an article after the Fed press briefing about inflation , money supply , and gold prices and dismisses the argument of currency substitution and transitory commodity prices.  In the process he shows a 20 year chart of money supply compared to the price of gold, which finds, as anyone familiar with historical inflation and gold prices already knows, that gold prices rise and fall and does not keep pace with inflation.

Given the Fed policy of a weak dollar, based on the weekly charts, the price of gold may not be going down immediately while it continues to test resistance levels, but if you have a basis of, say, $400 an ounce in gold and it is now over $1550, why would you not be locking in profits and continuing your original investment amount if you think it will still continue to rise and not fall?  Hyperinflation is not going to happen.  If the economy tanks and the dollar is worth little, how many bullets will it take to appropriate your gold?  On the other hand silver does appear to be peaking or approaching a peak with a significantly growing short position.  In just one weekend since the weekly charts above, silver went down 12% (the chart is ugly) with a low of $42.19 closing at $44.93 on Sunday (5/1/2011) trading and the COMEX may be facing a major default in a TBTF as there is supposition that J. P. Morgan, as the money maker for silver, was on the wrong end of the trade.  If you have an over 200% profit in silver, as I do in the personal (designed for use by an individual investor on their own) "hedge" fund portfolio model I have designed, or any 20% or better profit, why not lock in the profit while you have it?  It may not yet be the time to sell gold, but, in my personal opinion, it sure looks like a decent, prudent time to sell silver before the rush.  If you are in commodity ETFs, do not panic, but do not be complacent.  Make sure you have your stop loss or stop loss limit orders in place to limit losses and protect gains.  If you are in bullion or coins, you are hopefully near a reputable dealer.

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U.S. Treasury Market Says Nuts to S&P Warning

In last weeks Treasury auctions, which was the first full week since the S&P warned on the U.S. deficit, the U.S. Treasury auctioned 2 year, five year, and 7 year Treasury bonds.  All sold with healthy bid-to-cover ratios at yields lower than the prior month auctions for the same bonds.

2 yr. Treasury, $35 billion, yield .673% (last month .789%), bid-to-cover 3.07, foreign purchasers 37.9%, direct 13.4%.

5 year Treasury, $35 billion, yield 2.124% ( last month 2.269%), bid-to-cover 2.78, foreign 40.0%, direct 11.2%.

7 year Treasury, $29 billion, yield 2.712% (last month 2.895%), bid-to-cover 2.63, foreign 39.1%, direct 7.85%.



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Economic Growth & Inflation in the United States

 Earlier in the week, the economist Tom Duy wrote that he expected Bernanke on Wednesday to address growing inflation expectations while maintaining an unchanged monetary policy.  Most people have a very difficult time distinguishing between transitory headline inflation (which hits the wallet hard) and core, sticky inflation which consists of continuing price increases which impact prices and wages throughout the economy.  This is why inflation expectations can be an economic problem when transitory inflation exists, because people start expecting real core inflation and saving, which can slow the economy.  We have already written that Duy and others were very disappointed in Bernanke's over reaction to inflation expectations as opposed to real core inflation in his remarks and his failure to sufficiently address labor costs and unemployment.

U.S. GDP for Q1 was announced this week at 1.8% (analysts had expected 1.9%).  If you take a look at the different segments of GDP and their contribution to the total number, you will see an increase in imports and decrease in government spending which have a negative impact which far outweigh increases in exports and inventories which have a positive impact.  Growth this slow can often mean higher unemployment.  Until housing (which is on the edge of double dipping) and business investment improve, the trend of economic growth will continue to be slow and disappointing.

One guest writer at dshort.com did a chart on GDP with and without government spending included which, not unsurprisingly, showed that the number of years since 1960 with negative GDP growth more than doubled.  The proper purpose of government national deficits is a response to aggregate demand, as we have written, and its resulting in economic growth when there would have been negative growth it what it should do.  The dshort.com guest writer is concerned about the resulting debt when it should be the private sector growing, but he appears more concerned about deficit than why the private sector was not otherwise stimulated.

The U.S. also released this week its Personal Income and Outlays report for March which showed personal consumption expenditures (PCE) going up 6 tenths of a percent in March from February on the increase in food and fuel.  Personal income rose 5 tenths of a percent, but disposable income only rose one tenth of a percent.  Doug Short at dshort.com did updated charts on headline and core CPI and core and headline PCE and comparing core PCE and CPI against each other for two different time periods.  While we mere mortals cannot eliminate food and fuel from our consumption, the transitory volatility of food and fuel prices can be misleading in actual sticky inflation.  The price increases have to be continuous and impact production prices and wages to be core inflation.

This is also why I pay only passing attention to consumer sentiment, because it is such lagging, old information, which is why while inflation expectations are increasing right now, the consumer sentiment survey showed increased optimism.  Transitory inflation hurts, but, if inflation became sticky, the real pain sets in.  It is like a child becoming mildly sick but playing to sympathy and the parent does not sort the symptoms and behavior out and over reacts.  Going to the doctor, when it serves no good purpose, makes life all that more expensive.

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China: Copper In, Copper Out

We have written on several occasions how copper is being imported into China, placed in bonded warehouses, and used as collateral to gain access to credit.  This has led to a significant rise in copper prices.

The bonded warehouse inventories of copper are actually up despite less copper imports in China.  This means there may be no real demand for the copper other than as collateral and that it could constitute an oversupply which could negatively affect prices with destocking.  It appears that a variety of Chinese businesses, including possibly property developers, have been using copper in bonded warehouses for collateral.

As the holders of these copper inventories find it harder to rollover financing, they are responding by re-exporting copper in larger quantities to the extent that copper exports surged to 36,800 tons in March.  The two most popular countries to which the exports are sent are Singapore and South Korea, both of which have LME warehouses.  Rather than meeting Chinese productive demand, it appears much of the imported copper is being re-exported after a monetization pit stop in Chinese bonded warehouses.  Since it was never sold to a mainland buyer no VAT applied and the import - export transaction is tax neutral.

If the copper is not to meet internal demand which has remained price resistant, this has a direct effect on analysts projections of GDP and on the market price of copper if the import - pit stop for loans - export cycle continues to trend towards less import and larger exports.

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Bernanke Press Briefing

Some people have asked what Bernanke said today at the first ever Federal Reserve Chairman's press conference after a FOMC meeting.  The statement of the FOMC meeting had no surprises and even included the "extended period" phrase and sees inflation and unemployment as transitory.

The press conference began with a reprise of the statement and of economic projections.  In answering questions, Bernanke always focused on the "medium term".  Nothing surprising but it does reiterate his view of the economy and recovery from th4e financial crisis.

The full press conference including questions and answers can be watched and heard in full here.

Update 4/28/2011:  The economist Tom Duy takes Bernanke to task for too much emphasis on inflation and little regard for unemployment.

CalculatedRisk sees QE2 as just ending not tapering off, no chance of QE3 with the statements on inflation and unemployment, and interest rates not likely to go up until middle of 2012.

Krugman dismisses Bernanke's concerns about inflation and questions Bernanke's understanding of how serious the unemployment problem is.

Marshall Auerback provides an assessment of QE2 as counterproductive and destructive of the Middle Class.

The Australian economist Bill Mitchell rips Bernanke for his inflation fears, agreement with the S&P deficit warning, and finds the unemployment projections, despite remaining high, as optimistically unrealistic.

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Michael Pettis on China's Inflation & the US Dollar

Michael Pettis' private newsletter arrived by email on Monday and I am only allowed to excerpt from it.  Pettis began his newsletter by noting the recent Chinese economic data showing GDP Q1 at 9.7% year on year, CPI inflation at 5.4% in March, which was a 32 month high, and PPI inflation was 7.1% for March.  These figures were higher than what most analysts expected.  Pettis, however, does not believe these numbers mean much, because he continues to see the same pattern as the last two to three years of government reaction to overheating and then a resumption of acceleration.  Consequently, he expect the People's Bank of China to more aggressively raise rates and limit credit growth until those moves bite back.  Pettis sees nothing new here and everyone is just playing the expected game until the leadership change next year.

Maybe we will see a faster appreciation of the renminbi, because the market expects it.  The demand for renminbi denominated assets is so strong dim sum bonds are trading at negative yields.  This is what you would expect if there is speculation of a stronger renminbi.

With respect to Sunday's reserve hike, overall liquidity in the market is still high and he quotes Chen Long of Shenyin Wanguo as saying "Liquidity in the inter-bank system is sufficient as foreign exchange purchases by the PBoC have exceeded expectations despite the trade deficit.  Lending quota restrictions, however, have made it harder for borrowers in the real economy to get bank loans."  Pettis sees a paradox in the credit conditions, because "By some measures credit is very tight and borrowers are desperate to gain access to the limited loan quotas, and by other measures the market is drowning in liquidity."  While the percentage of bank loans as a part of total social financing is down, the proportion of entrusted loans and corporate bonds are up.  Credit is expanding faster than loan and deposit numbers would suggest.  For Pettis, the credit expansion is so great it is not useful to think of credit conditions as being tight even with so many desperate to access credit.  He argues "... that investment --- especially infrastructure, SOE and other official investment --- is so great that it is managing to overwhelm what would otherwise be considered very loose credit conditions.  If credit were in fact tight, growth would slow dramatically  but at least we would be rebalancing the economy and limiting future demand on household wealth transfers.  As it is, I don't think we are rebalancing at all."

The quarterly trade deficit was driven by commodity imports and was not unexpected as the Spring Festival quarter is always distorted.  He expects the trade account to bounce back with a big surplus unless "... a greater share of capital outflows are diverted into commodity stockpiling ...".  In fact, despite running a trade deficit, central bank reserves surged.  Net inflows were approximately $150 billion.  Given a trade deficit, there is renminbi exposure demand, such as those dim sum bonds, and hot money inflows seem to be increasing.

In an opposing view, Patrick Chovanec, who teaches at Tsinghua University, sees China's inflation problem as a problem of the money supply, because China buys all foreign currencies flowing in at a fixed rate and issues renminbi for domestic use.  He agrees interest rates are a part of the problem, but he believes the money supply has to be reined in.  Then the PBoC has to sterilize the increased money supply by taking money out of the economy by raising reserves.  Chovanec believes this is not sufficient to influence interest rates.  He sees letting the renminbi appreciate as necessary to establish economic tightening.  As low drawn out appreciation will only continue to attract inflows of hot money and the appreciation should be a dramatic one time revaluation of 20-30%.  Obviously, Pettis would point out, as he has on several past articles, this would be extremely disruptive of both private savings and consumption, business spending and investment, and wage expectations --- all of which would be not just economically disruptive domestically but potentially politically disruptive.


As Pettis wrote in a recent Financial Times op-ed entitled, "America Must Give Up On the Dollar", he continues his argument in this private newsletter because he believes it has a lot to do with China.  He points out that it seems as if every 20-30 years American current account deficits surge and dire warnings about the end of dollar dominance build.  "But I think these predictions about the end of dollar dominance are likely to be as wrong now as they have been in the past.  Reserve currency status is a global public good that comes at a cost, and people often forget that the cost is much higher than most countries are willing to pay."

Reserve currency status requires at least ample liquidity, central bank credibility, flexible domestic financial markets, deep and open domestic bond markets, and minimal government and political intervention.  As such, Pettis sees the euro as the only alternative currency, which I find unacceptable given the continuing eurozone credit crisis, of which I have written extensively, and the many qualities that eurozone credit crisis has consistent with a growing currency crisis.  In fact, as I have privately stated, it is almost as if the current account surplus euro nations are in a currency war with the euro current account deficit nations.  Pettis admits, however, that Europe would not be willing to pay the price of reserve currency.  He also says Switzerland is an example of a reserve currency based on national creditworthiness, but it the fifth most used and that volume is approximately one-half percent worldwide.  Additionally, Pettis is ignoring that the liabilities of the Swiss financial system exceed the GDP of Switzerland, which creates a systemically dangerous condition which the Swiss have been dressing with more financial regulation and higher capital reserves.

Still, he believes the United States should be encouraging the world to disengage from the dollar, because the global use of the dollar, in Pettis' opinion, is bad for the US economy and the global imbalances it creates.  Pettis sees the cost the United States as the choice between rising unemployment or rising debt.  Foreign acquisition of dollars causes the US to run a corresponding current account deficit.  The US must accommodate foreign trade policies diverting domestic demand abroad, which means the us must increase domestic consumption and/or investment to counteract the impact on employment.  "Without government intervention, there is no reason for domestic investment to rise in response to policies abroad.  On the contrary, I would argue that with the diversion of domestic demand, private investment might even decline."

Pettis believes the argument of reserve currency benefits in the form of reduced cost of imports and lower government borrowing costs are seriously flawed.  Americans already over consume and lower consumption means higher unemployment.  Thus, the US wants to increase exports and make imports somebody else's problem.  With respect to lower costs of government borrowing, Pettis sees that as a measure of creditworthiness, which is damaged by the current account deficits resulting from being the reserve currency.  "The supposed advantages of reserve currency status are simply the obverse of the cost.  As countries accumulate dollars, they force trade deficits onto the US, which the US can only manage by increasing borrowing.  This borrowing is financed by the foreign accumulation of dollars."

While that is factually correct, the Australian economist Bill Mitchell would argue that the sectoral balances are not being properly analyzed and there is a lack of appreciation of the inability of a fiat currency sovereign nation to default.

Pettis notes the massive imbalances which have been permitted are destabilizing as Joseph Stiglitz has also argued recently at INET and in the past as a need for a basket of currencies.  These are serious concerns but many economists and commentators look not at the imbalances and how to stabilize them, but focus wrongly on debt.  Pettis says, "If the world were forced to give up the dollar, there is no doubt that there would be an initial cost for the global economy --- it would reduce global trade somewhat and it would probably spell the end of the Asian growth model."  But he believes it would also reduce dangerous global imbalances.

Pettis ends his private newsletter with a a lengthy discussion of Kenneth Austin's recent article, "Communist China's Capitalism" published in World Economics (which is subscription read only), which is a re-reading of John Hobson's theories on underconsumption, which so many current students of economics under appreciate or are not sufficiently exposed to appreciate his contributions to modern economics.  Pettis finds it important and fascinating.  Austin finds the basic idea is that oversaving causes insufficient demand for economic output and in a closed society, excess savings cause recessions.  Basically Austin, according to Pettis, is arguing that under consuming countries like China are able to use the dollar today in the same manner that European countries used colonialism in the past to export capital and import foreign demand.

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