Monday, April 6, 2009

Sunday Night Economic Assessment

Continued gains in consumer confidence were implied again last week as the paperboard-based Consumption Index pushed further above its Dec-2008 bottom to its highest levels since late September 2008.

The Production Index, as it did last week, balked at the trend... and slumped toward its February 13th bottom. Within the gas-flows (on which the production index is based) flows into steel plants were extremely week, perhaps representing easter-related or temporary resession-related shut-downs, or perhaps (more frearfully) representing increased foreign imports.

The combination of a stronger dollar (pushing down foreign goods pricing) and lower oil prices (ratcheting down shipping costs) could prompt a flood of imports into the US, further depressing industry in spite of strengthening consumer spending. If that were to happen, visions of the US consumer having to lift the whole world out of recession (to avoid a US industrial depression) would be realized. Once past Easter, we need to see both consumer spending hold, and industrial production to uptick, to continue this weak, fragile recovery.

This week I have included a bit of a mystery in the above chart. Take a look at the light blue line. Can you guess what it is?

Note the succession of lower-lows and lower highs. For the TA folks on board, what would a chart like this tell you? Would you invest in a stock with a chart like this? Or does this resemble a company in bankruptcy. No, it isn't Bear Sterns or Leahman or General Motors. It isn't even a stock. (Clue, the time-frame is compressed and the price exaggerated to fit the chart. The actual indicator starts at 12.81 on October 1980, peaks at 19.10, and ends at 0.22 on February 2009.

The above blue-line kind of reminds me of my grandmothers heart-monitor (when I was young) when she was in the hospital. We lost her the next day. But in this case, that blue-line could be said to be the heart-monitor of our countries financial health. It is the Federal Reserves "Discount Window", the Federal Funds Overnight Monthly Published Rate.

The problem behind this "US Heart-Monitor" is it is indicative of a need from the economy for ever lower-and-lower interest levels to stave-off recession. Like a drug addict needs higher-and-higher doses of his drug to "get high", the economy needs higher-and-higher doses of it's drug (Interest rate relief) to get its high (economic recovery). Some of us have been watching the Fed-Funds rate for a very long time, wondering what happens when zero-percent gets hit, and it's not enough. I believe this is why the Fed/Treasury are in panick mode right now... they sence that zero may not be enough, and are flailing around trying to find something else that might work... in fear of depression.

All this started back in the late 70's (when I first started trading) when US inflation was a really big problem. A man named Paul Volker (very respected at the time) was brought in to chair the Federal Reserve to fight inflation. Interest rates were tightened to restrict the growth of the United States' core money supply (M1) to halt inflation.

Since then, the means to stimulate the economy (get more money into the hands of spenders) has been to coax them to borrow to spend... through progressively lower-and lower interest rates with each recession or economic slow-down.

The result... consumers borrow and spend... the money goes to businesses & savers... who deposit the money back into the bank... for consumers to re-borrow and spend... the money goes to businesses & savers... who deposit the money back into the bank... for consumers to re-borrow and spend...

The government even joined the fun... engaging in deficit spending... the money went to businesses & savers... who bought government debt... issued for the purposes of deficit spending... sending the money to businesses and savers...

All this culminated in both a growing debt bubble (IOU's) and a growing asset-bubble (UOI's)... as both personal debts and money supply (M2) pumped eachother up. All worked well as long as growing IOU's equalled growing UOI's... though the inflation-hawks worried about the rapid growth of M2 & M3 (until the Federal Reserve got too scared to continue to publicly release its M3 measure), and the credit-hawks worried about the rapid growth of debt of all kinds.

Then came the credit crisis of 2008, and the dreaded "Mark-to-market".

As housing values plunged and the US sank into recession in 2008, loan-delinquencies shot up, and markets for mortgage-securities seized up as values plunged. Under mark-to-market rules, hundreds-of-billions, then trillions of bank assets had to be written off, while the homeowners (on the other side of the loans) retained the obligations of their mortgages. The result was that bank assets (UOI's) disappeared much faster than mortgage obligations (IOU's), creating a situation where (as I understand) the asset-bubble began deflating faster than the debt-bubble (in the eyes of thier respective holders), creating a negative balance (or charge against) the actual (M1) money supply.

As I understand it, it is concievable that the net temporary effect of this is that we may actually have little if any real net money supply, maybe even an effectively negative money supply, given the discrepancy between the unwinding of the two pools, and that may be behind the seeming panick of the Fed & treasury in their attempt at quantitative easing. It would also be behind the rise in the US dollar.

Given the growth in US population, and the growth of world use of the US dollar, the money supply growth (M1) should parrallel the growth of the share of the worlds population that uses it. We may be a long, long way below that.

Hence the use of lower interest rates to spur spending, with all its disasterous consequences.

Using low interest rates to entice spenders further into debt is a poor way to attempt to exit a recession. As is giving trillions to banks and special-interests and waiting for it to trickle down to the consumer. In reality wealth tends to trickle up (to the saver) rather than down (to the spender). As the saying goes, the rich get richer, and the poor get poorer.

The US has prospered throughout its history through stimulation of both ends of society... saver and spender. In reality, spenders cannot prosper without savers to fund the ventures productive of the goods they wish to buy, and savers cannot prosper without spenders to buy the goods produced by their productive ventures. The spender needs the saver, and the saver needs the spender. Both need a wise, wholistic government.