Thursday :: Jan 5, 2006

Blowing The Piper's Bubbles

by pessimist

The Santa Ana winds are howling here in SoCal this morning, and in the immortal words of W. C. Fields, "It's not a fit night out for Maaaaaaaan nor beast!"

It's a good thing that my house is reasonably immune to the effects of these winds, but what of the house of cards constructed by Bu$hco out of what was once the world's strongest economy? How well can that stand up to the howling winds of economic change?

A president of the Federal Reserve claims that the US is at 'full employment' while the latest mass layoff making the headlines in the MSM screams otherwise.

Are the economic warning signs being ignored?

While the signals coming from the economic pundocracy may be solid green, the ones coming recently from the marketplace are flashing yellow.

* A middling Christmas season for retailers.
* A bicoastal housing boom that has already begun to abate, with an initial 10 to 15 percent drop in prices from speculative highs.
* A stock market that couldn't sustain a year-end rally despite record profits.
* A bond-market yield curve that makes it no more expensive to borrow money at a fixed rate for 30 years as for one year. [the 'inverted yield curve' - ed.]

Other warning signs:

* A corporate sector unable to find a more profitable use for its record retained earnings than buying up its own stock or overpaying for questionable acquisitions.
* Hedge funds so flush with cash that they are lending money into a commercial real estate bubble, bidding up the price of gold and financing hostile takeovers.
* Pay packages for corporate executives and investment bankers up 30 percent in a year in which investors were lucky to eke out a 3 percent gain.

I have a hard time squaring so many disquieting realities with a consensus forecast that has the economy gliding into some magical macroeconomic equilibrium.

So do I. There are too many things going on that dispute the contention that all is well with the American economy - and the world knows it!

This is the year that the world's major economies will have learn to live without easy money. Removing this stimulus without choking off growth in Europe and Japan or taking the wind out of the housing market in the United States will be an exceedingly delicate, if not risky, task. "This is a high-wire act," said Thomas Mayer, the chief European economist at Deutsche Bank in London. "The global economy has been propped up by huge liquidity. The question is, How do you take this liquidity out of the economy without the whole thing crashing down?"

No problem! Make it harder for Americans to buy houses!

The Federal Reserve and other government agencies proposed tighter lending standards on mortgages today, saying unconventional loans warrant strong risk management. The guidelines recommend that lenders base loans on the borrower's ability to repay the money even after low-rate introductory offers.

Have the lenders not been doing this all along? Or, were they instead borrowing a page from the credit card lenders?

"Credit cards want you to stay in debt as long as possible, that's the way that make their money. So as soon as you can get out from under their clutches, out from under the hammer the better off you're going to be," says Financial expert Carl Williams. In fact, credit card companies made about 30-billion dollars in 2004... all from interest charges.

So who is going to care about housing mortgages going to those who can't really pay for them, anyway? The new bankruptcy laws ensure that there will be no release from debt no matter what!

The dropoff in consumer bankruptcy petitions since the nation's bankruptcy law changed belies the fact that there are still many Americans in serious financial trouble.

And why should anyone care about this, anyway? It's not like we live in Argentina, or anything!

No, we don't live in Argentina, which after many years is getting out from under a massive economic collapse, but there are signs that we are facing less prosperity than what we are being promised by Bu$hCo - and American bankers know this:

"A housing downturn, in part triggered by the Fed’s policy actions, will become more pronounced as the year progresses, placing consumer spending, credit-quality, and job creation at some risk," said Scott Anderson, Wells Fargo senior economist.

[G]ross domestic product growth will tail off to 3.1% in the third quarter next year, remaining at that pace in the fourth quarter also. GDP growth in the third quarter this year came in at 4.3%. For 2006 as a whole, GDP is forecast to come in at 3.4%, compared with 3.6% in 2005.

"The primary driver of this slowing is consumer spending. Spending will be hurt by continued elevated energy prices and a slowing in housing," said Merrill Lynch economist David Rosenberg.

Already, data releases are showing consumers are not quite as eager to spend money on expensive items like cars as they were earlier this year when both interest rates and gasoline prices were much lower. Also, as interest rates have risen, the level of home-loan refinancing has declined, leaving consumers with less money to spare.

Despite all of the hapy talk about how many new jobs were created under Bu$hCo stewardship, only in America does the media miss this vital connection between employment and prosperity:

Consumer spending, which accounts for two-thirds of the economy, has traditionally been dependent on the health of the labour market. National Bank economist Yanick Desnoyers believes a diminishing U.S. real estate 'wealth effect' will be the bigger culprit. "Recent consumption growth has been mostly spurred by the housing sector's strength and not the job market," he said.

The clues suggesting an 'inevitable' slowdown in the U.S. housing sector looms are numerous, he said:

* existing unsold housing inventory is at a five-year high;
* the affordability index is at a 20-year trough;
* housing starts are running far ahead of demographic trends;
* home ownership rates are starting to fall, despite record housing sales;
* rising property taxes are restricting new ownership;
* access to real estate financing is getting tighter.

If the U.S. consumer clamps down on spending next year, "the Federal Reserve will face a highly delicate situation," Mr. Desnoyers said.

Can't buy that new Hummer if you can't hock the house to pay for it! Nor should you, especially if you work for an American-owned company. The odds are that very soon you won't be making as much money as you have been:

Many of the country's manufacturing workers are caught in a worldwide economic shift that is forcing companies to slash payrolls or send jobs elsewhere, leaving workers to wonder if their way of life is disappearing. The trend in the manufacturing sector toward lower pay, fewer benefits and fewer jobs is alarming many of them.
"They're destroying the working class. Why can't people see this?" asked Gary Colflesh, 56, of Bloomingdale, Ohio. "Anybody who works in manufacturing has no future in this country, unless you want to work for wages they get in China."
Michael Balls of Saginaw, Mich., hears the argument that U.S. companies' costs are too high to compete with plants that pay workers less overseas, but he doesn't buy it. "If I'm making $9 an hour, I'm not making enough to buy vehicles."

Abby Abdo, 52, of Weirton, said workers once believed that if they accepted pay cuts and shunned strikes, they would keep their jobs. Not anymore.

"Once they get what they want, they kick us to the curb," he said. "There's no guarantee anymore. No pensions. No health care. No job security. We have none of those things anymore."

Former Clinton Administration Secretary of Labor Robert Reich thinks all the economic happy talk would wither quickly if the way we look at national economic health were more realistic:

[L]et me end 2005 by asking what may seem an impertinent question: What’s the point of economic growth if most people aren’t any more prosperous?

Listen to most economic commentators and you’d think the biggest news of 2005 was that the American economy continued to grow at a healthy clip—notwithstanding hurricanes, oil shocks, trade imbalances and a bloated federal budget deficit. Well, that’s true. The power and resilience of this economy are remarkable.

But there’s another story about the American economy that’s equally remarkable, although more sobering. Although the data aren’t all in, it seems almost certain that in 2005, median incomes continued to drop. Rarely before in history has there been such a long period of growth in the gross domestic product without most Americans sharing in that growth.

Take inflation into account and you find that half of all American workers are earning less now than they did in 2001.
Forget "trickle-down" economics. Even if you believe the Bush tax cuts of 2001 and 2003 helped the economy grow — and if you do, you probably believe in Santa Claus — nothing is trickling down, not even to the middle. Most is going to the top fifth. And most of that is going to the top 5 percent.

Maybe it’s time we stopped measuring the success of the American economy by how much larger the GDP is from one year to the next, and started using a new measure that reflects how most of us are doing from one year to the next. Instead of GDP, let’s look at what might be called the MDP — Median Domestic Prosperity. The American economy is strong when the MDP is rising, weak when it’s falling.

When it declines for four years in a row, we’re in an MDP recession.

Thanks to the easy credit and readily available mortgage refinancing in the recent past, this dire economic situation has been hidden behind conspicuous material consumption arranged through easy credit, but as Bob Dylan once sang, "The Times They Are A'Changin'"!

[T]ighter monetary policy will slow economic growth towards the second half of 2006.

"In recent years, borrowers have been able to bring trades at the tightest possible levels, but now that they have to raise money, rather than tapping the market to get cheap funding, investors should see themselves as being in a better position."

When "59 percent of Americans said they incurred or acquired credit card debt last year" and "nearly 32 percent said it took them more than three months to pay off this credit card debt", then is it any wonder that "spending less money was in order" - even before one looks at the decreased earning prospects of the American working class?

The investors can see this situation clearly even if Bu$hCo can't - or won't. The knowledgeable investor is heading for the hills. Them GOLD hills, that is:

Unnerved investors turn to gold

As if gold was not telling us already, the Bank for International Settlements has reported in its latest Quarterly Review on how a deterioration in the outlook for inflation unnerved investors “around the world” over September and October, and how central bankers in the US and the euro area have accordingly signalled that monetary policy might need to be tightened.
The key focus of attention has been rising energy costs and the inflationary effect thereof, with oil still 30% above year-ago levels in September despite embarking on a decline.
Meanwhile investors’ appetite for risk has been diminishing and this, combined with growing uncertainty of the economic outlook (here too, gold tells its own story) has resulted in increased volatility in the equity markets.

This volatility can in part be laid at the feet of the Federal Reserve fiscal management policies dating back to the '90s according to one financial columnist, who says that, under Alan Greenspan, The Bubble Cycle is Replacing the Business Cycle:

To try to restore some degree of confidence in "the System," as Greenspan calls it, the Fed injected liquidity in 1994 that restored function to a dysfunctional banking system and rescued the bond market. But what cures one bubble sows the seeds of new ones.

As Martin Mayer said in his book The Fed:

"The truth is that liquidity, the only significant weapon remaining in the central bank's arsenal as decision making moves to the markets, will not necessarily go where you want it to go when you need it to go there."
Ever since markets overran the Fed in the creation of money and credit in the late 1970s, the Fed has overseen a series of bubble booms and bubble busts. But with such a high level of corporate and household debt, and capacity globally at historical highs, the Fed runs a very real risk that the real economy will fall into a deflationary depression.

The multiple bubbles we are living with now are likely to burst as a result of the Fed current tightening cycle that started in June 2004.

If the pattern of the last two tightening periods holds for this cycle, there is reason to expect that at least some of these bubbles will pop sooner rather than later.
[Author Eric Janszen's] expectation is that the reflation effort that follows the bursting of the housing, bond, and dollar bubbles that formed during this reflation cycle are more likely to result in a period of high inflation than following previous cycles. The reasons for this are more political than economic. [P]oliticians, who are in a position to address the problem of the bubble cycle before it becomes an even bigger problem, are not motivated to examine the issue carefully today:
"Having won supervisory control over the entire financial services industry, the Fed must bring into the light where the markets can see them continuously the now hidden maneuverings of the private banking empires, the derivatives dealing, the over-leveraging that accompanies over-reliance on diversification and probability. And the Fed has never believed in sunshine as a disinfectant.
The tragedy for all of us would be if the Fed's and the Treasury's and the Congress's reverence for people who make a lot of money left us unprotected against some sudden revelation of the truth that becomes obvious only in hindsight, that a lot of them don't know what they're doing."

Maybe that observation also applies to the rest of us. As the current focus of the MSM - the West Virginia mine tragedy - illustrates, that hindsight truth is slowly dawning with the people of West Virginia and of Ohio about King George and his inept and incompetent self-serving governance of this land.

The Piper is just about finished playing the tune - and payment is definitely expected immediately upon conclusion of the performance. Hyperinflated currency will only make him angry, and the rest of us will be expected to pass the hat to cover that expense deficit with our jobs, our posessions, and our American Way of Life.

And we wonder why Iraqis aren't flocking to embrace it when we offer it to them at the point of a gun!

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