No double-dip recession in sight, risk premia falling

To continue the “animal spirits” update:

There is no double-dip recession in sight.  There is a natural pulse to the economy, and it is stabilizing.  The damage done to effective demand is huge, however, and there is a chance that the natural pulse has been stopped.  However, without an inversion of the yield curve a further pronounced downturn is exceedingly unlikely.  The yield curve was inverted in 1928-1929 and before every postwar slump (and there never failed to be a slump after an inversion; if anyone can provide me with Treasury yield curve data for the 1920s and 1930s I would appreciate it).  Also, before every postwar recession the unemployment rate has risen toward its adaptation level and crossed it almost exactly at the onset of the recession.  Currently, the “animal spirits” variable is forecast to rise even with rising unemployment.  Here is the recession “probability” for the coming year:

 

As I have been forecasting all year, the RP = Baa – Aaa risk premium has fallen sharply in the past month, so this trade has worked out nicely.  This is research, however, not investment advice.  Risk premia may fall more slowly for several years, until the next slump.

From my perspective, the two things that will signal the next collapse will be an inversion of the 1/10 Treasury yield curve, and the unemployment rate rising toward its adaptation level from below.  Currently the adaptation level is 6.1 while the print unemployment rate is 9.4.  This process is forecast to take several years.  See the last “animal spirits” update for details.

0 percent 10-year employment growth

Via:  NYT  According to data cited by Floyd Norris, the U.S. population has increased 10 percent or 28 million, from 279 million to 307 million, but employment growth has been flat.  (See the next chart for the actual employment series.)  And among those who have incomes, income inequality has grown sharply.  The next panic will probably be worse than the Panic of 2008.

 

To be fair here is the BLS Civilian Employment series according to FRED, which shows employment at November 2004 levels (note log scale).  The current slump has been the most proportionally damaging to employment in the postwar period.

Will rising “animal spirits” lead to ruin?

With the decline in the unemployment rate this morning, “animal spirits” improved.  We should see improvement in the Michigan Consumer Sentiment Index going forward, although it has slipped a bit recently.  There is noise in all economic series.

Click on chart for larger image in new window.

Even with unemployment climbing to about 11 percent over the next year, confidence will improve until the A metric (reference) actually becomes positive in time for the election, barring a currency crisis or other catastrophe in the meanwhile.  Confidence is one of the primary drivers of the business cycle.  However, given the double-whammy to consumption I noted yesterday from falling wages and salaries and increased saving, and the collapse of investment demand, growth is likely to be very, very slow.

This is bad news, in my view, as it affords the opportunity for the fiscal and monetary authorities to continue to pile up debt on the backs of American taxpayers.  Bernanke and Geithner will continue to bail out the bad debts of some big banks at taxpayer expense, and Congress will continue to rack up world-war-like deficits.

America can not service the debt load it has now.  Credit market debt is about 375 percent of GDP, higher than it was in 1929 according to reliable estimates.  Consumer and business debt is charging off at high rates likely to get worse.  As government crowds out private borrowing, private defaults can be expected to rise even more.  Since a lot of bad private debt of Wall Street firms is being converted into “good,” “risk-free” U.S. Treasury debt, this amounts to a continuation of the greatest expropriation of the ordinary Americans by the rich interests in American history.  Almost none of the high-rolling Wall Street speculators or their institutions have paid any price whatsoever for their trillions of dollars of bad bets.  (There was Lehman, but that was personal, Hank Paulson’s pet revenge project.)  At some point, demand for the dollar will collapse and rising import prices will drive the standard of living of the average American down even further.

We are watching an empire self-destruct in slow motion.  At the end of this process America will truly be a banana republic, with income and wealth inequality far worse than they are now, a hollowed-out state.  As McKinsey notes in a recent study, the human capital of the American labor force is subpar.  How will we climb back out?  The rich are free to invest their money anywhere in the world.

Only a radical reordering of American priorities in the next couple of years will prevent this.  There is no one who believes the Bush-Obama deficits projected over the next ten years are sustainable.  Ron Paul is the only elected politician who is addressing the scope of the change needed.  Everyone else appears to be playing politics as usual, acting as servants to the rich.  Even a five percent surtax on incomes over $1 million to provide health coverage to the poor has been fought tooth-and-nail by our greedy over-class.  The rich in this country have lost all sense of fiscal fairness in the worst crisis in three generations.  Ron Paul is the only politician of any standing who correctly diagnoses the problem, imperial over-reach inevitably leading to ruin.  As a physician, he has even moderated his libertarian positions to support government-sponsored health insurance for the poor, paid for by ending our futile wars.  I would add to that livable workfare for the unemployed to see them through the crisis, which is likely to last a decade or more.

Finally, is the unemployment report real?  Many would say not.  See TrimTabs’ research (here and here) and ShadowStats.  The Labor Department itself shows a decrease in the labor force of over four million in this decade.  Do you believe none of these folks want jobs?  All they have to do, reputedly, is to stop looking for a month and they’re out of the labor force.  The employment-to-population ratio is dropping sharply.  The government is aware of the psychological impact of the unemployment rate number so they manipulate it to keep it down.  The true unemployment rate is already in the teens.  A growing awareness of this reality may undercut the forecasted rise in confidence levels.

Click on chart for larger image in new window.

Falling incomes, increased saving fuel collapse of consumption

Via:  Bloomberg  Note the double-whammy of incomes down, saving up.

American Incomes Head Down, Threatening Recovery in Spending

By Shobhana Chandra

Aug. 5 (Bloomberg) -- Household income in the U.S. is weakening as the influence of the government’s stimulus plan wanes, prompting economists, Federal Reserve officials and a Nobel laureate to warn that consumer spending may struggle.

“Consumers have started to change their behavior and they are going to save more,” said Richard Berner, co-head of global economics at Morgan Stanley in New York and a former researcher at the Fed. “You have pressure on wages, you have employment still declining.”

Wages and salaries, which drive recoveries in spending, fell 4.7 percent in the 12 months through June, the biggest drop since records began in 1960, according to Commerce Department figures released yesterday. The Obama administration’s tax cuts, extended jobless benefits and a one-time Social Security bonus have helped mask the damage done by the worst employment slump since the Great Depression.

Personal incomes, which include interest income, dividends, rents and other payments as well as wages, tumbled 1.3 percent in June, more than forecast and the biggest drop in four years, yesterday’s Commerce report showed. Excluding the effects of the stimulus plan, June incomes would have dropped 0.1 percent after no change in May, according to the report. In May, one-time additional payments to Social Security recipients boosted incomes 1.3 percent.

One of every 10 American workers will be without a job by early 2010, economists project, shaking the confidence of those still on payrolls and discouraging spending. It may take as long as 15 years for consumers to fully repair finances battered by the decline in home values, stocks and employment, said Edmund Phelps, winner of the Nobel prize in economics in 2006.

Shrinking Net Worth

Decreasing pay is not the only hurdle for consumers. Plunging home prices and stocks reduced household net worth by a record $13.9 trillion from the third quarter of 2007 through this year’s first quarter, according to figures from the Fed.

“Households are going to have to do an awful lot of rebuilding of their wealth,” Phelps, a professor at Columbia University in New York, said this week in an interview on Bloomberg Television. “Even if that rebuilding goes on at a pretty good clip, it will take 12 or 15 years for households to get to the wealth level that they had several years ago. Consumer demand is going to take a long time to rebuild to normal levels.”

In the second half, incomes and spending will be hurt by the loss of transitory factors such as lower fuel prices, decreased tax rates and the one-time payment to retirees, William Dudley, president of the Fed Bank of New York, said in a speech last week.

Save More

“Consumer spending is unlikely to rise much faster than income” because of the need to boost savings, he said. “Weak income growth will be an effective constraint on the pace of consumer spending.”

Companies continue to trim expenses, threatening further cuts in pay and benefits. Tenneco Inc., the world’s largest maker of vehicle-exhaust systems, temporarily lowered pay and hours worked to reduce labor costs by 10 percent. Earlier this year, the Lake Forest, Illinois-based company suspended contributions to employees’ 401(k) retirement accounts and cut pay for the top 50 executives.

Government assistance such as the “cash-for-clunkers” program will help postpone the inevitable increase in savings and slowdown in spending as more baby boomers approach retirement, said David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto.

“Spending is in desperate need of gimmicks like cash-for- clunkers in order to grow on a short-term basis,” he said.

Lifting Auto Sales

The program, which offers as much as $4,500 for trading in older, less fuel-efficient cars, ran through its $1 billion fund in about a week, and Congress is considering adding $2 billion. Auto industry data this week showed sales jumped to an 11.3 million annual pace last month, the highest level since September.

Mounting joblessness is among reasons that economists such as Rosenberg say will prompt Americans to save more. Unemployment, already at a 26-year high of 9.5 percent in June, may top 10 percent by early next year, according to the median estimate of economists surveyed by Bloomberg last month.

Economists estimate that a Labor Department report at the end of the week will show employers cut an additional 328,000 workers from payrolls in July. That would bring the total loss of jobs since the recession began in December 2007 to 6.8 million.

The savings rate in June fell to 4.6 percent as incomes dropped, yesterday’s Commerce Department report showed. The rate, which reached a 14-year high of 6.2 percent the previous month, is likely to keep climbing, Rosenberg said. A rate as high as 15 percent can’t be ruled out, he said.

“This is a different consumer than we had in the past 20 years,” Rosenberg said. “People are going to increasingly be putting more money into cookie jars, rather than into buying more cookie jars.”

Essential links 8/4

Via: ZH and NC

• Personal spending rose 0.4% in June. Incomes fell 1.3%, biggest drop in four years. Max out those credit cards while you can. (Bloomberg)
• China has become a giant ponzi scheme - Chinese stocks are 50-100% overvalued (Andy Xie, via Ritholtz)
• Must read: from plasma physicist to Citadel's nemesis - profile of Misha Malyshev (Crains)
• Bernanke's exit dilemma (WSJ)
• Federal tax revenues plummeting (AP)
• Bank regulators dig in against Obama shake-up Reuters

Markets built on sand

Via:  George Washington  Can you spot which shell the bean is under?  Nice job, George.

The Real Economy Versus the Make-Believe World of the Government and Financial Giants

 

In the real economy, unemployment is at Depression-era levels (see this, this and this).

In the real economy, bank loan loss rates will be higher than the Depression.

In the real economy, government revenue is at its lowest level since the Depression, and most states are on the verge of bankruptcy.

In the real economy, the world economy is crashing faster than during the Depression (and see this).

But in the make-believe world of the government and the financial giants, the recession is over.

How do they do it?

Well, as I noted a couple of days ago, the boys use:

• High-frequency trading, program trading-based frontrunning, and other computer-based manipulation of the markets

• Creation and manipulation of bubbles

• The Plunge Protection Team

• Intervention in the gold, currency markets, and bond markets

• Bear raids, naked short selling, and credit default swap holders driving companies into bankruptcy

In addition:

• Years ago, the government reporting some basic economic indicators like M3, and moved away from real economic indicators like U-6 unemployment and inflation and substituted economic indicators like "U-3" and "core inflation" to cover up what is really happening

• Normal accounting and reporting rules have been suspended, so that companies can pretend that worthless derivatives, CDOs, subprime mortgages and other "toxic assets" are worth perhaps time times more than they are really worth. Indeed, as of 2006, "President George W. Bush has bestowed on his intelligence czar ... broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations." One or more treasury department officials also actively allowed banks to "cook their books"

• Bernanke is apparently almost single-handedly responsible (using the Fed's network of primary dealers) for the current rise in the stock market

• The government also uses its preferred dealers to launder money through the Exchange Stabilization Fund (ESF), to prop up the dollar or otherwise game currencies

• The largest derivatives holders use their Counterparty Risk Management Policy Group (CRMPG) to literally collude - exchange secret information and formulate coordinated mutually beneficial actions - all with the government's blessings

• Wall Street analysts just ignore fines, penalties and expenses in earnings projections (in the words of a Bloomberg commentary, they "Keep Telling Big Earnings Lie")

• The sales of U.S. Treasury bonds are heavily gamed. Indeed, as Rob Kirby and Ellen Brown point out, Bernanke and the boys apparently use hedge funds in the Cayman Islands to launder huge sums of dollars printed by the Fed to secretly buy U.S. treasuries:

In 2005, ... this scheme evidently went into high gear, when China and Japan, the two largest purchasers of U.S. federal debt, cut back on their purchases of U.S. securities. Market "bears" had long warned that when foreign creditors quit rolling over their U.S. bonds, the U.S. economy would collapse. They were therefore predicting the worst; but somehow, no disaster resulted. The bonds were still getting sold. The question was, to whom? The Fed identified the buyers as a mysterious new U.S. creditor group called "Caribbean banks." The financial press said they were offshore hedge funds. But Canadian analyst Rob Kirby, writing in March 2005, said that if they were hedge funds, they must have performed extremely poorly for their investors, raking in losses of 40 percent in January 2005 alone; and no such losses were reported by the hedge fund community. He wrote:

The foregoing suggests that hedge funds categorically did not buy these securities. The explanations being offered up as plausible by officialdom and fed to us by the main stream financial press are not consistent with empirical facts or market observations. There are no wide spread or significant losses being reported by the hedge fund community from ill gotten losses in the Treasury market. . . . [W]ho else in the world has pockets that deep, to buy 23 billion bucks worth of securities in a single month? One might surmise that a printing press would be required to come up with that kind of cash on such short notice.⁴

In September 2005, this bit of wizardry happened again, after Venezuela liquidated roughly $20 billion in U.S. Treasury securities following U.S. threats to that country. Again the anticipated response was a plunge in the dollar, and again no disaster ensued. Other buyers had stepped in to take up the slack, and chief among them were the mysterious "Caribbean banking centers." Rob Kirby wrote:

I wonder who really bought Venezuela's 20 or so billion they "pitched." Whoever it was, perhaps their last name ends with Snow [referring to then-Treasury Secretary John Snow] or Greenspan.

Those incidents were apparently just dress rehearsals for bigger things to come. In late 2005, the Federal Reserve (or "Fed") announced that beginning in March 2006, it would no longer be publishing figures for M3 (the largest measure of the money supply). M3 has been the main staple of money supply measurement and transparent disclosure for the last half-century, the figure on which the world has relied in determining the soundness of the dollar. But the curtain was now to drop. What was it that we weren't supposed to know? March 2006 was also the month Iran announced it would begin selling oil in Euros. Some observers suspected that the Fed was gearing up to use newly-printed dollars to buy back a flood of U.S. securities dumped by foreign central banks. Another possibility was that the Fed had already been engaging in massive dollar printing to conceal a major derivatives default and was hiding the evidence. [See this and this.]

But the problem isn't just that the government and financial giants are hiding the bad news in the real economy.

The bigger problem is that the government has been strengthening the parasite - the fake economy of derivatives and securitization and leverage and cut-outs and front men and cooked books - and poisoning the real economy.

We are living through interesting times on a paleontological, evolutionary time scale

Lest there be any doubt we are living through interesting times on a paleontological, evolutionary time scale, read the first reference for evidence that we’re living through a major extinction event, and the second for evidence that humankind is hitting the wall with respect to growth of all kinds and is entering a phase transition to, one hopes, a sustainable state of affairs:

• The sixth extinction – Peak Watch h/t kedrosky.com
• Finite-time singularity in the dynamics of the world population, economic and financial indices – Sornette and Johansen (here is a non-technical version)

Someone asked me at Seeking Alpha over the weekend what my program was, that I was “confusing,” didn’t seem to fit an ideological mold.  That is correct. 

My program is basically this: 

(1) provide all unemployed Americans with a livable poverty level dole and provide all Americans with health insurance (not the same as “socialized medicine,” which means the government runs everything); and

(2) let the economy self-organize.

Instead of macroeconomic funny numbers, make human welfare outcomes the target of the “objective function.”  And do it mercilessly, no addition to debt.  If it requires income redistribution, so be it. 

Combine this with a ruthless writing-off (liquidation) of bad debts, letting the chips fall where they may, and recovery will come a lot faster than any other way.