By Michael Trinkle, ForexTraders

Two of the most powerful people in the world will speak Thursday morning concerning the global economic outlook.  The EUR/USD has moved up slightly during the London session on the heels of positive bond auctions in Spain and France; however, the market was unable to bid prices up beyond yesterday’s HI’s at 1.2855 as investors wait for European Central Bank President Jean-Claude Trichet to speak at 8:30 am and Fed Chairman Ben Bernanke at 9:00 am.

Although today is heavy with key risk events, the market may not break out of its trading range until the Non-Farm Payroll release tomorrow morning.  NFP tends to be one of the most revered key leading indicators of economic health, and the market may be hesitant to commit to large directional positions before the NFP confirms economic direction.

Trichet

As stated, the euro found strong support this morning as a result of strong bond auctions in France and Spain.  Strong bond auctions are expected in France, but the market is still watching Spain, Portugal, Greece, Italy, and Ireland very closely.  For several months now, we have been writing about the possibility of the EuroZone Debt Crisis re-emerging this fall.  One of the leading indicators that will show the EuroZone is again in serious trouble will be when and if these struggling countries face difficult bond auctions.  As of yet, there is still plenty of investor demand for these bonds, but if the fiscal concerns do become serious enough that investors are unwilling to buy Greece, Portugal, Spain, Ireland, or Italy’s bonds, then there will most likely be a huge bout of risk aversion that sweeps the market once again.

European equity markets remained subdued even in light of the positive bond auctions as investors were unwilling to bid prices up before Trichet speaks this morning.  The market will be watching and listening closely to see whether Trichet formally commits to extending liquidity to help the European banking system.  GDP blew past market expectations in the 2nd quarter.  The expected figure was 0.7%, and the actual figure came out at 1.0%, which was quite surprising considering the systemic problems the EuroZone faced during the Q2 with its Debt Crisis.  However, Germany was able to benefit enormously from a cheap euro as its exports were much more attractive to foreign buyers, and that increased exporting activity in Germany helped overall EuroZone GDP tremendously.  Now, many economists are concerned that economic growth will slow significantly in Q3 as the euro has strengthened during the last 3 months.

Trichet is also expected to cast a cautious tone concerning economic outlook, but traders will be listening closely for any new verbiage or departure from his normal mood of cautious optimism.  Trichet has also been championing fiscal austerity in developed nations, saying that countries such as the U.S. should turn to decreasing government spending.  Interestingly enough, Fed Chairman Ben Bernanke is actually about to the do the exact opposite as he and the rest of his Board Members at the Fed are currently preparing to inject another round of fiscal stimulus into the U.S. economy.

Bernanke

Today, Fed Chairman Ben Bernanke will be testifying before the Financial Crisis Enquiry Commission in Washington DC.  Bernanke’s testimony comes in 2 parts:  a written, prepared statement and an open Q&A session with the Congressional board.  The prepared statement does not generally move the market as most of his verbiage will most likely be as expected, but during the Q&A, his answers to tough questions oftentimes offer a clearer picture to investors concerning the Federal Reserve’s next steps.

The most likely scenario in the United States is that the economy will enter into a prolonged period of very sluggish growth.  Mr. Bernanke has been communicating this view consistently, but he is concerned that the very sluggish growth could pull the U.S. into a deflationary period, which can be disastrous for an economy and can lead to a decade or more of virtually no economic growth.  This fear is why Mr. Bernanke and the Federal Reserve are seriously considering yet another round of quantitative easing.  They are willing to do anything to stimulate the economy back into robust growth.

Market Price Action

Yesterday, we mentioned the euro was beginning to put pressure on resistance to the upside.  We currently have some very fascinating price action beginning to develop between the euro, pound, and dollar.  Generally, the EUR/USD and GBP/USD move in very tight correlation.  However, we have been seeing that correlation break down over the last few days.  This morning, U.K. Nationwide HPI came out below the market expectation of -0.3% at -0.9%.  This surprise to the downside led the pound to move lower in the immediate aftermath of the release and then to drift sideways and lower throughout the London session.
 
On the other hand, the euro has again moved to the upside during the London session today.  The economic outlook and Central Bank leaders in the U.S, U.K. and EuroZone are diverging.  In the EuroZone, Trichet is by far the most hawkish concerning interest rates and monetary conditions, and the EuroZone is also posting pretty good economic data relative to these other countries.  Therefore, the euro is beginning to move higher, and if economic data continues to back up Trichet’s decisions, we could see the euro move up quite a bit versus both the dollar and pound in the coming weeks.

Of course, the elephant in the room concerning the EuroZone is the possibility that any day the EuroZone Debt Crisis could begin to erupt again, but currently those fears seem to be on the backburner.  If the sovereign default concerns in the EuroZone can remain contained, then the euro could move up quite nicely in the next few months.

We have been calling for a huge drop in the euro at some point in the latter part of 2010, but the reality is that will most likely not happen as long as the Debt Crisis remains under control.  As a trader, be on the lookout for the first signs of major fiscal trouble in struggling EuroZone countries.

More articles from ForexTraders….

The Daily Reckoning

Since I am known as something of a gold bug, a lot of people write to me about gold, but since I am a paranoid lunatic, I don’t read their letters, mostly because I now call myself Marvelous Macho Grande (MMG), figuring that an established alias could potentially come in handy when the prices of gold, silver and oil shoot higher and higher as inflation in consumer prices starts going parabolic as a result of the despicable Federal Reserve creating so, so, so much money, especially so that the despicable federal government can borrow and spend that selfsame so, so, so much money.

So, you can see how a dramatic, romantic new name like Marvelous Macho Grande (MMG) would perfectly suit a guy like me, which is a guy with a theoretical massive coming increase in wealth from investing according to The Mogambo Perfect Portfolio (TMPP), which uses the Austrian school of economics (see Mises.org) and the last few thousands of years of history as Absolutely Compelling Reasons (ACR) to invest in gold, silver and oil when the government is acting so insanely bizarre, as does ours now, blithely deficit-spending a monstrous 11% of GDP, now with a national debt nearing a heart-stopping 100% of GDP, and allowing the Federal Reserve to continue to create So Freaking Much (SFM) money that, like creating too much money always does, it creates booms and bubbles that predictably, inevitably, unstoppably, disastrously go bust, leaving you, sadly, worse off than before.

So, you can see how I am not in the mood to answer emails from people who, deep down in their hearts, are pleading, “Oh, please help me, Masterful Mogambo Guru, or Marvelous Macho Grande (MMG), or whatever in the hell your name is this week: Sadly, I have not been following your terrific advice to buy gold, silver and oil as the One True Way (OTW) to end up with a lot of money without working for it, and now I need one of your famous Secret Investment Plans (SIP) to make up for lost time, else I am reduced to being the widow of a rich Nigerian banker who needs to sneak $100 million out of Nigeria and into your country. In that case, I will give you $50 million after you give me your bank account number and $5,000 in cash to pay various fees, expenses and bribes.”

Alas, I don’t have $5,000 to invest in this terrific opportunity to make a quick $50 million, as likewise there are no Secret Investment Plans (SIP), although I have spent a lifetime looking for one.

Fortunately, constantly buying gold, silver and oil is always the smart thing to do when your stupid, desperate, half-witted, corrupt, clutching-at-straws government is acting like all the other stupid, desperate, half-witted, corrupt, clutching-at-straws governments that created too much money and destroyed themselves over the last 4,500 years.

And if you don’t believe me, then maybe you will listen to the famous Richard Russell of the Dow Theory Letters, who writes, “Investors sometimes get caught up in the day to day and week to week movements in gold and silver. Don’t waste your time or energy on that, just accumulate. Standing in front of us is the greatest transfer of wealth in history. When the dust settles, those holding the gold will make the rules.”

And “just accumulate” sounds so easy because it is so easy, which is why I say, as I always say until you are tired of hearing me say it, “Whee! This investing stuff is easy!”

The Mogambo Guru
for The Daily Reckoning Australia

Similar Posts:

• Silver and its Large Short Position
• Gold is the Only Place to Turn in Times of Inflation
• Two Good Reasons to Own Gold
• Borrowing Money is no Longer in Fashion
• Fearing the Elimination of Reserve Requirements

More articles from The Daily Reckoning….

The Daily Reckoning

Well, August washed up. It was the worst month for US stocks in almost a decade. And yesterday didn’t help. The Dow couldn’t manage a rally. It rose just 4 points.

The British newspaper, The Telegraph, has the story:

Those fears took centre stage again during the final day of trading.

In New York, markets enjoyed some brief respite from the blizzard of weak data as reports on the US housing market and consumer confidence proved better than feared. The Conference Board’s index of consumer confidence climbed to 53.5 last month from 51 in July, while the latest reading from the respected S&P/Case-Shiller index showed that home prices were up 4.2pc in June compared with a year ago.

The day’s rally proved short-lived, however, after the minutes of the Federal Reserve’s latest meeting returned investors to the summer’s familiar themes. Fed chairman Ben Bernanke has spent the past few weeks facing increasing pressure from markets to publicly declare he will do more to fight the prospect of a second recession if the recovery stumbles further. According to the minutes, some members of the Fed’s Open Market Committee saw “increased downside risks to the outlook for both growth and inflation”.

That admission left the Dow up just 4.99 points at 10,014.72 for the day, while the S&P ended the day up 0.41 at 1,049.33.

As predicted on this page, both Martin Wolf and Paul Krugman are taking the low road. Not that we wouldn’t take it too, were we in their position. They urged the Obama team to undertake massive programs of “stimulus.” Now that the stimulus hasn’t worked, they say it wasn’t massive enough.

And thank God the administration at least took some of our advice, they add. Otherwise, things would be a lot worse!

In today’s Financial Times, Wolf refers to a recent paper by Alan Blinder and Mark Zandi. The two use a “standard macro-economic model” to determine that without the feds’ intervention the decline in GDP would have been three times worse and unemployment would have risen to over 16%. And, can you believe it, we would have had a federal deficit of $2.6 trillion.

Oh man, oh man…we’re so grateful to Wolf, Krugman, Summers, Obama, Bernanke and all the other savants who protected us from such a dreadful fate.

But wait a minute, this “standard macro-economic model” sounds great and all…but we can’t help but wonder. It can predict precise outcomes based on federal policy inputs, right? That is, if the feds were to do such and such…it tells us what will happen, right? And Wolf says it’s “standard,” so we imagine that you can get it at any Wal-Mart or filling station. So, the Obama team must have had it two years ago, right? We can’t help wonder if this was the same model they used when they forecast that unemployment wouldn’t go over 8% – if Congress agreed to the stimulus bill the administration proposed. Must have been a different one… Because Congress did pass the stimulus bill and unemployment rose over 9% anyway.

And it’s still over 9% – almost 2 years after the stimulus effort got underway.

So, maybe this “standard macro-economic model” is full of… But let’s imagine that it isn’t. Let’s allow our imaginations to take flight…to soar…to loose themselves from the gravity of worldly cares or practical reality. Let’s imagine that these economists have a clue!

Imagine that the feds had done nothing – which was more or less standard policy for the nation from its founding in 1776 up until the middle of Herbert Hoover’s term in 1930…and for all the years that preceded them…all the way back to the founding of Rome. Now, let’s imagine that Blinder and Zandi are right. Without fed intervention, GDP would have sunk 12% – three times more than the actual loss…and half the loss of the Great Depression. Well, that would have been a disaster, right?

Well. Maybe not. It might have been a blessing. The point of a correction is to correct. The Blinder/Zandi study tells us that the economy had mistakes equal to 12% of GDP. Okay…well, maybe the correction overshoots. Who knows? But think of the crazy years of the Bubble Epoque…when lenders were giving unemployed people a mortgage for 110% of the inflated value of a house. Think about the Private Equity deals based on growth assumptions that were hallucinatory. Think about the hundreds of trillions’ worth of derivatives based on complex formulae that were phony and silly? Think of all the decisions made on the assumption that consumer credit would continue to expand as it had from 1949 to 2007. Was one of every 8 of them too optimistic? Too ambitious? Too unrealistic? We’d be surprised if there weren’t more errors…far more than 12% of GDP.

Now ask yourself…what good was done by failing to correct those mistakes? By failing to wash out the excess debt? Failing to allow insolvent banks to go broke? Failing to permit worn-out, uncompetitive businesses to die in peace?

We don’t know how many mistakes there were. We don’t know how far GDP SHOULD go down. And we don’t know what would have happened if willing buyers and sellers had been allowed to sort themselves out in the age- old ways – by panic, default, bankruptcy, restructuring, and reconstruction.

We don’t know. We’ll never know. But there is no reason to think we’d be any worse off if we’d found out a year ago. A 12% drop in GDP might have been just what we needed. We could be on the road to prosperity now, rather than looking at another 5 to 15 years of stagnation, decline, and desperation.

And more thoughts…

But we have good news. Yes, dear reader, genuine, no-doubt-about-it good news.

Two bits of good news, actually.

First, the café across the street from our office serves a proper café au lait. A real one.

In Paris these days, if you ask for a “café au lait” they mark you as a foreigner. Parisians ask for a “café crème.” Trouble is, the café crème doesn’t have much milk in it. It tends to be a bit watery and bitter.

A proper café au lait, on the other hand, is served with a little pitcher of hot milk. Not many cafes in Paris still serve it that way – unless you ask them specifically. Fortunately, the one across the street still does it the right way.

Second, and perhaps more important, we discovered yesterday that tea- totallers die sooner than heavy drinkers. This comes as a great relief to your editor. He sat down last night with a bottle of Lussac St. Emilion to celebrate.

Here’s the story from John Cloud (originally appearing in Time Magazine):

Why Do Heavy Drinkers Outlive Nondrinkers?

One of the most contentious issues in the vast literature about alcohol consumption has been the consistent finding that those who don’t drink actually tend to die sooner than those who do. The standard Alcoholics Anonymous explanation for this finding is that many of those who show up as abstainers in such research are actually former hard-core drunks who had already incurred health problems associated with drinking.

But a new paper in the journal Alcoholism: Clinical and Experimental Research suggests that – for reasons that aren’t entirely clear – abstaining from alcohol does actually tend to increase one’s risk of dying even when you exclude former drinkers. The most shocking part? Abstainers’ mortality rates are higher than those of heavy drinkers.

Moderate drinking, which is defined as one to three drinks per day, is associated with the lowest mortality rates in alcohol studies. Moderate alcohol use (especially when the beverage of choice is red wine) is thought to improve heart health, circulation and sociability, which can be important because people who are isolated don’t have as many family members and friends who can notice and help treat health problems.

But why would abstaining from alcohol lead to a shorter life? It’s true that those who abstain from alcohol tend to be from lower socioeconomic classes, since drinking can be expensive. And people of lower socioeconomic status have more life stressors – job and child-care worries that might not only keep them from the bottle but also cause stress-related illnesses over long periods. (They also don’t get the stress-reducing benefits of a drink or two after work.)

But even after controlling for nearly all imaginable variables – socioeconomic status, level of physical activity, number of close friends, quality of social support and so on – the researchers (a six- member team led by psychologist Charles Holahan of the University of Texas at Austin) found that over a 20-year period, mortality rates were highest for those who had never been drinkers, second-highest for heavy drinkers and lowest for moderate drinkers.

The sample of those who were studied included individuals between ages 55 and 65 who had had any kind of outpatient care in the previous three years. The 1,824 participants were followed for 20 years. One drawback of the sample: a disproportionate number, 63%, were men. Just over 69% of the never-drinkers died during the 20 years, 60% of the heavy drinkers died and only 41% of moderate drinkers died.

These are remarkable statistics. Even though heavy drinking is associated with higher risk for cirrhosis and several types of cancer (particularly cancers in the mouth and esophagus), heavy drinkers are less likely to die than people who have never drunk. One important reason is that alcohol lubricates so many social interactions, and social interactions are vital for maintaining mental and physical health. As I pointed out last year, nondrinkers show greater signs of depression than those who allow themselves to join the party.

The authors of the new paper are careful to note that even if drinking is associated with longer life, it can be dangerous: it can impair your memory severely and it can lead to nonlethal falls and other mishaps (like, say, cheating on your spouse in a drunken haze) that can screw up your life. There’s also the dependency issue: if you become addicted to alcohol, you may spend a long time trying to get off the bottle.

That said, the new study provides the strongest evidence yet that moderate drinking is not only fun but good for you. So make mine a double.

Bill Bonner
for The Daily Reckoning Australia

Similar Posts:

• Government is Still Misleading and Economists are Still Mis-interpreting
• America Completes Collection of Welfare State Essentials With Health Care System
• Most Government Services Are Disservices
• Almost Every Mortgage Written Last Year Underwritten by US Government
• Mr. Market Never Gets a Say on Government Jobs

More articles from The Daily Reckoning….

Zero Hedge

Seeing Past The Hologram, by Mike Krieger of KAM LP

There is no distinctly American criminal class – except Congress.

- All quotes by Mark Twain

We Need Real Confidence to Return, Not Confidence in a Ponzi Scheme

Last week I pointed out that what I got from Banana Ben’s speech in Jackson Hole was that he realized any major public statement of interference in markets was too risky at this point following his announcement at the last meeting to keep the balance sheet steady by reinvesting MBS proceeds into treasury securities.  The operative word in this sentence being “public.”  Anyone that believes this means the Fed and government will just take a back seat and do nothing behind the scenes is deluding themselves.  Washington D.C. and the Fed still fail to comprehend how to increase standards of living in the real world, rather they remain completely addicted to the short-term buzz of printed money heroin as it flows through the house of cards they have created.  They also think that the only thing that really matters in an economy is “confidence.”  As Madoff can attest to, that is indeed the case when you are running a ponzi scheme and since the U.S. government is basically that I can understand where they are coming from.

 I agree that confidence is a huge part of any healthy economy; however, I do not define confidence in the way these arrogant bureaucrats do.  They think confidence comes from rising asset prices, including stocks and homes.  They think this is enough to spark growth in the real economy.  This is nonsense.  The confidence that is needed more than anything else today is two-fold.  First, confidence that there is the rule of law and there will be the rule of law in the future.  The second is that the money issued by the government will maintain its purchasing power over time.  As I have made clear on various occasions, I do not have confidence in either of these things based on how the government has responded to the crisis.  I do not like buying physical gold.  I do not like feeling the need to write these emails every week to warn people.  I wish I could employ capital into businesses and the real economy.  I hope that one day I will be able to do so, but at the moment I do not trust my government and I certainly don’t trust the fascist Federal Reserve.  So I will hoard what I have as the government prints and let the storm pass me by.  I am not the only one.  People are collectively starting to understand this.  So what happens when the big, smart money takes itself out of the investment and capital allocation game because they don’t trust anything?  What happens when the government’s response to this is to print money to keep up the spending habits of people with no jobs or people with government jobs that produce no goods for the economy?  You get the worst case scenario and that is exactly what is staring us straight in the face.

Is a Trade War with China Coming?

The quicker the dollar is devalued the better.  This is not to say that I think dollar devaluation is a good thing.  It is to say we are past the point of avoiding it.  We could have taken the pain in 2008, but instead it was extend and pretend all over again.  Now the debt and promises are too big.  The behind the scenes manipulations are too entrenched.  There is no avoiding a devaluation relative to things people need (food and energy) and capital goods that are imported.  The best thing would be to get it over with and then change policies and restore the rule of law.  The problem with this is that the main currencies the dollar needs its major adjustment against are those in emerging Asia and China.  What has prevented the realignment from happening in a quick and healthy way is China’s refusal to allow the yuan to appreciate.  This creates a situation where Central Banks throughout emerging Asia take steps to prevent their “free-floating” currencies from adjusting either.  If China does not change its policy I fear that what we are looking at a trade war with China after the November elections.  I think Congress and the Administration will start to introduce aggressive policies to discourage Chinese goods and encourage goods made at home.  Think it can’t happen?  We are a lot closer than you think.  This all goes back to my “think local” theme.  While I am inherently a fan of free trade we do not have free trade in any sense whatsoever.  We have policies that are geared to advantage the multi-national corporations at the expense of the U.S. citizen.  The U.S. consumer has merely been spending borrowed money.  This gave an illusion that the U.S. was benefiting from the global multinational corporate rigged market whose model mainly thrives on companies moving abroad to exploit the labor arbitrage caused by a combination of what was a labor surplus (no longer it seems) and a rigged currency.  As more people realize this, more pressure will be placed on politicians and ultimately this will overpower the corporate lobbyists and a trade war of sorts will begin.  Then the chaos could really ensue as we engage in a trade war with our biggest creditor!

Seeing Past the Hologram

The past couple of weeks have been extraordinarily interesting and some of the moves appear to be extremely important.  Although a lot of people like to point to the treasury market and then extrapolate out as to what this means to equities and the ability of the government to increase spending, I think this is the most USELESS market in the world to watch.  If anything is a hologram and a PR tool it is the U.S. treasury market.  How can people with a straight face come out and extrapolate anything from a market where the Federal Reserve is buying the debt of its own government!  The Fed is merely the fiat drug dealer to a government addicted to spending and false promises.  The equity market is the second most useless market in my opinion.  There is no doubt in my mind that a huge part of the government’s “strategy” to build confidence is to keep this thing from doing what it should be doing.  Thus, I am not surprised at all that since I last wrote the S&P500 was +1.6%, -1.5%, flat, and then +3.0%.  So what you have seen is high volatility with no real direction.  How can anyone have confidence this that thing is for real?

So what markets do I watch?  I get the most from the FX markets and the commodity markets.  While these markets are no doubt manipulated heavily as well, I think this is where the players that really understand the macro are playing.  The first currency I check in the morning is the dollar/yen.  The reason for this is that the yen is back to the highs of 1995 and if it does not stop appreciating around this level I think the Bank of Japan is going to absolutely panic.  While the yen has not broken higher yet as market participants are afraid of such intervention, unless the BOJ does something extreme soon the market may test their resolve and push this thing further.  I guess the main point I am trying to make is that with the Chinese yuan NOT strengthening and the yen threatening to break out we could be in for some major fireworks.  Meanwhile Japanese 10 year government bond yields have really started to spike lately (chart GJG10 Index on Bloomberg).  Something big is happening in the land of the rising sun.  In the back of my head I think that any panic move from the BOJ could be the spark that breaks government bond bubbles globally and ushers in a period of massive global commodity driven inflation as every country tries to devalue their way to prosperity.  Essentially, a fiat money version of the 1930’s beggar thy neighbor policies.  When this begins the rush into gold and silver that we have seen thus far will look like a trickle.  I don’t think people will be able to find supply anywhere near the quoted price on comex (or as some like to call it “crimex”).

This brings me to silver which potentially experienced a game changer last week.  I can’t remember the last time silver bounced back almost immediately after every attempted raid.  I am starting to wonder how much physical silver is available.  What we do know is that Central Banks do not store silver to manipulate markets.  Even if it doesn’t break out right now, there is no asset in the world that has more upside than silver.  Don’t buy SLV either.  Buy physical silver not something with JPM as a custodian. 

I also continue to watch food prices very closely.  Wheat, which has come off of its high now seems to have found a base at a price that is 50% higher than the end of June.  Corn prices are threatening to break above resistance at levels 30% where they were at the end of June.  Rice looks like it could have a long way to go on the upside as it is only 20% off of its June low.  If I were a foreign government I would be using this opportunity to buy every single grain of rice I could in order to feed my people when things get dicey in the months ahead.  After strong performance in recent months lean hogs and live cattle also look set to make another push to the upside.  How people in the investment world still focus on the government inflation statistics is beyond me.  It was the rampant commodity inflation, trucker strikes and food riots that played a key role in ending the game in 2008.  This is because it forced the emerging markets to raise rates and cool growth as the Western world imploded under a pile of debt.  It seems the whole play is starting again and people remain focused on deflation.  Deflation in some things yes I agree (discretionary things like homes, technology, stock prices, etc), but not in the things you NEED to buy!!!

Onto oil which is also exhibiting some strange moves.  The Asian benchmark Tapis has not experienced the recent volatility and weakness that WTI has and is currently trading at $80/b.  The Asian price is the one I really pay attention to since that is where the demand growth resides.  The spread between the two now is back above $6/b, which is toward the high end of the range for the past two years.  This tells me that one price is wrong and the spread should narrow.  Given what I think about currency debasement and lack of appropriate investment in the space I think WTI should rally.  We shall see…

A Primer on the Federal Reserve

For those that read my commentary on the Federal Reserve as an immoral an fascist institution and think to themselves “what is this guy talking about,” I have attached a video from G Edward Griffith (the author of The Creature from Jekyll Island).  It’s a great description of how the Fed was formed and who it answers to when push comes to shove.  http://video.google.com/videoplay?docid=6507136891691870450#

Also in case you weren’t aware of the power grab that the “Financial Reform” legislation allowed the Fed, read this Bloomberg article. 

http://www.bloomberg.com/news/print/2010-09-02/bernanke-meets-buffett-in-new-role-conceived-to-protect-markets.html

All the best,
Mike

More articles from Zero Hedge….

If one wants to be taken seriously in the world of policy analysis, one should at least use an internally consistent framework. This consideration, apparently, has not troubled Mr. Reidl.

To quote from The fatal flaw of Keynesian stimulus, in the Washington Times:

Last week, the Congressional Budget Office released a report claiming that the $814 billion “stimulus” has added 3.4 million net jobs.

…

Such implausible analysis does not come from actually observing the post-stimulus economy. Rather, it comes from Keynesian economic models that have been programmed to conclude that government spending injects new dollars into the economy, thereby increasing demand and spurring economic growth. In other words, these models are programmed to conclude that stimulus spending always creates jobs and growth, no matter how the economy actually performs.

Well, not quite. As I described in this post, there are a variety of ways in which multipliers are obtained. Oftentimes, the impacts are estimated either directly or indirectly, by estimating the marginal propensity to consume. The article continues:

But there is one problem with the government stimulus theory: No one asks where Congress got the money it spends.

Congress does not have a vault of money waiting to be distributed. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another.

It is intuitive that government spending financed by taxes merely redistributes existing dollars. Yet spending financed by borrowing also redistributes existing dollars today. The fact that borrowed dollars (unlike taxes) will be repaid some years later does not change that.

Here, I think Mr. Riedl is invoking Ricardian Equivalence, despite the fact that there is no empirical evidence, to my knowledge, that validates pure Ricardian Equivalence (actually, Ricardian equivalence wouldn’t necessary hold for government spending on goods and services, anyway). Now, at this juncture, I thought that he might be invoking a real business cycle model, or an older, nonstochastic version of the RBC, namely a flex price Classical model. But then the next paragraph reads:

Some believe stimulus spending is the mechanism by which the Federal Reserve injects new dollars into the economy. Yet the Fed could run the printing press and then inject those dollars into the economy by buying existing bonds (with mostly inflationary results). It doesn’t need an expensive stimulus bill to conduct monetary policy.

Accepting that the Fed can stimulate via monetary policy then implies either (1) sticky prices so an expansionary monetary policy can affect the real interest rate, or (2) a financial accelerator model such that collateral constraints or some other financial rigidity holds. In the latter case, it seems prima facie that Ricardian Equivalance cannot hold.

Next, I was thrown for a loop, because Mr. Riedl seems to conflate real saving and the monetary multiplier. He argues that government deficits can only be financed by foreign saving, private saving and “idle saving”. This he describes thus:

Idle savings. The only government spending that truly increases current purchasing is the amount that would have otherwise sat idle in safes and mattresses. Those are the only dollars not already circulating through the economy as consumption, or through the financial markets as investment spending.

Idle savings are rare. People and businesses generally invest or bank their savings, where the financial markets transfer them to other spenders. Banks that receive savings either lend them out to a spender, or (when afraid to loan) invest them conservatively to earn some interest. They are not hoarding customer deposits in massive vaults (beyond the required cash reserves).

This is an odd conflation of saving, measured as a flow, and financial assets. But lets take the equation at face value, there is an incredibly counterfactual observation that there no reserves are behing held in excess of required cash reserves. According to the St. Louis Fed, excess reserves are now approximately $1 trillion dollars. Well, no need for facts to get in the way of a good polemic.

Mr. Riedl’s main point is:

All government stimulus spending requires first borrowing dollars that would have otherwise been applied elsewhere in the economy. The only exception is money borrowed from “idle savings,” which for reasons described above likely constitute a minuscule portion of the $814 billion stimulus.

As I’ve mentioned here and elsewhere, this is true in a full employment model. (I’m working off of textbook models; move to coordination models, or allow monopolistic power, and you have lots of other inefficiencies arising).

Mr. Riedl concludes:

Economic growth requires raising worker productivity to create more goods and services. Government stimulus spending represents a naive “magic wand” attempt to create purchasing power and wealth out of thin air.

No wonder the unemployment rate remains high.

Well, if we’re in a Classical world, then there is no involuntary unemployment. If we’re in a New Classical world, then whatever involuntary unemployment exists is not systematic. If there is involuntary unemployment, then there are resources that are not being utilized, and putting them to use naturally raises productivity (remember labor productivity is defined as output per man hour).

It pains me to say that Mr. Riedl is a graduate of the University of Wisconsin, in economics and political science.

Postscript: Here is Deutsch Bank’s assessment of the impact of the ARRA on the growth rate of GDP.

Figure 1: Dobridge, Hooper, Slok, Sufian, “The growing risk of fiscal drag in the US,” Global Economic Perspectives, New York: Deutsche Bank, July 28, 2010.

Level impacts are depicted in this post. Here is CBO’s latest assessment.

Read more….

Readers of my articles will recall that I have warned as far back as December 2006, that the global banks will collapse when the Financial Tsunami hits the global economy in 2007. And as they say, the rest is history.
Quantitative Easing (QE I) spearheaded by the Chairman of Federal Reserve, Ben Bernanke delayed the inevitable demise of the fiat shadow money banking system slightly over 18 months.

Read more….

Zero Hedge

As part of the Fed’s latest QE iteration, it has already been made clear that despite initial disclosures that the Fed would stay in the 2-10 Year bound of Treasurys, Ben Bernanke is now also gobbling up the very long end of the curve. For all those who are, therefore, still confused why bonds continue to surge to record levels, don’t be: when there is a guaranteed bidder just below you in the face of the Fed, and who you can turn around and sell to at will, there is no pricing risk. The problem, from a bigger stand point, is what happens when the Fed is actively buying up 30 Year bonds with impunity and the much desired (by the Fed) inflation still does not appear? Well, the Fed then, in Michael Pento’s opinion, will begin to purchase stocks and real estate. And as all those who enjoy comparing the US to Japan can attest, outright purchases of securities by the Japanese government is a long-honored tradition in the ongoing fight with deflation in Japan. However, and as the recent BOJ (lack of) intervention demonstrated, Japan never could do anything with the required resolve, and bidding up one stock here and there would never achieve anything. Which is why in this interview with Eric King, Michael Pento makes the case that as opposed to the occasional market intervention via the President’s Working Group, Bernanke will soon make stock purchases an outright policy of the Federal Reserve as its last ditch attempt to engender inflation before the hundreds of billions of Commercial Real Estate and other bank debt start maturing in 2011/2012. Bernanke is running out of time and he knows it. And once the Fed becomes the bidder of last resort in stocks, all bets are off, as the Central Bank will become the defacto only market in virtually every risky category. And the only safe vehicle, once the market then begins to price in Fed driven asset-price hyperinflation, will be gold.

Pento also provides some perspectives on the Fed’s balance sheet, which he anticipates will expand in a “great fashion”, but a much bigger concern to the recent Euro Pacific Capital addition, is the possible surge in M2: “That base money can expand, M2 which is currently running around 8.5 trillion all the way up to nearly 25 to 30 trillion dollars of money supply and that’s enough obviously to send prices through the roof.” All Bernanke needs to do is light the “alternative asset purchasing” match and all those who wonder what left field hyperinflation could come out of, will get their answer.

Of course, it wouldn’t be a Pento interview without a requisite smack-down, in this case of Dennis Gartman, whose call to sell gold denominated in euros at the very bottom of the recent gold correction needs no further commentary: EUR-denom gold has jumped well over 10% since Gartman said to get out. Pento adds the following: “There is so much misinformation out there, Dennis Gartman was out there saying gold has lost its inflation hedging properties: this is just ludicrous and insane. I can tell you that gold will never lose its inflation lure, and that’s precisely why I’ve stepped up my purchases of gold., I see what the monetary base is doing, I can clearly see Bernanke’s next step to vastly increase the size of the balance sheet and the monetary base. So for me, it’s 100% an inflation hedge.”

Pento also goes into explaining why housing is facing a “deflationary depression,” and a further collapse in pricing, why inflation benefits only those closest to the money, i.e., the banks and the military complex, why it destroys the middle class (we are sure Buffett ca. 2003 could say something about that too… the current, far more senile and captured Uncle Warren, not so much), the impact on discretionary purchases, on unemployment, real incomes, and all other items which tend to “follow the money.”

Lastly, Pento concludes with an analysis of what would have happened had the government allowed the deflationary depression to occur two years ago, without the tens of trillions in bank bailouts. We protracted, and elongated the depression. But instead of having the benefit of falling prices, you have rising prices.” And if Pento is right, the price rise has only just begun.

Full King World News interview here.

More articles from Zero Hedge….

By Karl Denninger, The Market Ticker

As is my usual practice…..

Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets during the period since the Committee met on June 22-23, 2010. He also reported on System open market operations during the intermeeting period, noting that the Desk at the Federal Reserve Bank of New York had engaged in coupon swap transactions in agency mortgage-backed securities (MBS) to substantially reduce the number of the Committee’s earlier agency MBS purchases that remained to be settled.

We made sure that those who sold us things they didn’t have didn’t get called on it.  Isn’t that grand?  (PS: What do you call selling something you don’t actually own – and can’t acquire?)

In addition, the Manager briefed the Committee on the System’s progress in developing tools for possible future reserve draining operations. The Federal Reserve successfully conducted two more small-value auctions of term deposits to confirm operational readiness for such auctions at the Federal Reserve and at the depository institutions that chose to participate.

Who were those that "chose to participate"?  Oh yeah, that’s right, we dont’t get actual minutes – what we get is another fraudulently-claimed load of bilge.

There were no open market operations in foreign currencies for the System’s account over the intermeeting period.

…. that we’re willing to admit to……

Staff Review of the Economic Situation
The information reviewed at the August 10 meeting indicated that the pace of the economic recovery slowed in recent months and that inflation remained subdued.

Translation: There was no recovery.  Not now, not before, and certainly not on a forward basis.

In addition, revised data for 2007 through 2009 from the Bureau of Economic Analysis showed that the recent recession was deeper than previously thought, and, as a result, the level of real gross domestic product (GDP) at the end of 2009 was noticeably lower than estimated earlier. Private employment increased slowly in June and July, and industrial production was little changed in June after a large increase in May. Consumer spending continued to rise at a modest rate in June, and business outlays for equipment and software moved up further. However, housing activity dropped back, and nonresidential construction remained weak. Additionally, the trade deficit widened sharply in May. A further decline in energy prices and unchanged prices for core goods and services led to a fall in headline consumer prices in June.

The government lied previously, and still is.  We of course used this as an excuse, and still are.

Private nonfarm employment expanded slowly in recent months. The average monthly gain in private payroll employment during the three months ending in July was small, considerably less than the average increase over the preceding three months.

When adding in the population of new entrants to the workforce, employment did not expand at all, it actually FELL.  But we won’t tell you that, because that’s would be "truth", and we’re allergic.  Severely.  Oh, we’re missing our epipens too.

The unemployment rate moved down in June from its level earlier in the year, and was unchanged in July, as declining civilian employment was accompanied by decreases in labor force participation. Initial claims for unemployment insurance remained at an elevated level over the intermeeting period.

We don’t count people who have given up on finding a job as "unemployed."

The output of high-technology items and other business equipment continued to rise.

Yeah, Intel says so too.  Oh wait….

Indicators of household net worth–such as stock prices and house prices–were little changed, on net, over the intermeeting period. Consumer confidence fell back in July, with households expressing greater concern about their personal finances and the outlook for the recovery.

Our lies are not working as well as they used to.

The housing market, which had been supported earlier in the year by activity associated with the homebuyer tax credits, was quite soft for a second consecutive month in June. Sales of new single-family homes rebounded some in June after their sharp drop in May, but they remained at a depressed level. Sales of existing homes fell for a second month in June, and the index of pending home sales suggested another decline in July.

The government cheese ran out.  Damn.

Inflation remained subdued Deflation accelerated in recent months.

Nominal hourly labor compensation–as measured by compensation per hour in the nonfarm business sector and the employment cost index–rose modestly during the year ending in the second quarter. Average hourly earnings of all employees rose slowly over the 12 months ending in July. Output per hour in the nonfarm business sector declined in the second quarter after rising rapidly in the preceding three quarters. On net, unit labor costs remained well below deflated below their level one year earlier.

In the emerging market economies (EMEs), incoming data generally pointed to a moderation of economic growth, albeit to a still-solid pace, with a notable slowing in China in the second quarter.

China has better liars than we do.  They also use bullets on truth-tellers more often.  (Those in the US telling the truth often have "heart attacks."  Funny coincidence, that….)

In contrast, Mexican indicators suggested that economic activity rebounded in the second quarter after contracting in the first quarter.

The Mexican drug gangs are shooting more people, which is leading to a pickup in demand for guns and ammunition.  This is expected to spur economic activity and reduce competition for jobs.

Over the intermeeting period, investors appeared to mark down the path for monetary policy in response to weaker-than-expected economic data releases and Federal Reserve communications that were read as suggesting that policymakers’ concerns about the economic outlook had increased.

Investors are losing confidence in our lies too.

Reflecting the same factors, yields on nominal Treasury coupon securities fell noticeably on net. Treasury auctions were generally well received, with bid-to-cover ratios mostly exceeding historical averages. Yields on investment- and speculative-grade corporate bonds decreased, and their spreads relative to yields on comparable-maturity Treasury securities declined moderately. Secondary-market bid prices on syndicated leveraged loans rose a bit, while bid-asked spreads in that market edged down.

Net-interest margin is collapsing. Incidentally, this is threatening to expose the naked swimmers among our banks – and their insolvency.

Broad U.S. equity price indexes increased slightly, on net, as generally positive corporate earnings news and an easing of investors’ worries about the potential effects of fiscal strains in Europe were partly offset by concerns about the strength of the economic recovery. Most firms in the S&P 500 reported second-quarter earnings that exceeded analysts’ forecasts.

"Work harder, get paid less, or be fired and we’ll send your job to a slave labor camp in China!" – the new mantra of American business.

Gross bond issuance by U.S. investment-grade nonfinancial corporations rebounded in July from relatively subdued levels in May and June.

There’s always a greater fool….

Prices of commercial real estate appeared to have increased in the second quarter, though the number of transactions was small.

One building sold – from Guido to Guido’, for the purpose of establishing a fraudulent mark on the price.

Nonetheless, commercial real estate markets remained under pressure. Delinquency rates for securitized commercial mortgages continued to rise in June, and commercial mortgage debt was estimated to have contracted by a sizable amount again in the second quarter. However, investor demand for high-quality commercial mortgage-backed securities (CMBS) reportedly was robust, although issuance of CMBS remained muted.

Oh crap – we printed three sentences of truth!

Consumer credit contracted again in the second quarter, as revolving credit continued to decline and nonrevolving credit edged down.

Consumers are done with this BS and are choking on debt.  Having been hosed twice in ten years, they’re refusing to do it again.

Commercial banks’ core loans–the sum of commercial and industrial (C&I), real estate, and consumer loans–continued to contract in June and July.

That’s called "default".

Securities holdings by banks increased substantially in recent weeks.

But the banks are buying stocks!  (Ed: are they using depositor funds to do that, or are they using Fed-printed money?  Either is a problem, no?)

Staff Economic Outlook
In the economic forecast prepared for the August FOMC meeting, the staff lowered its projection for the increase in real economic activity during the second half of 2010 but continued to anticipate a moderate strengthening of the expansion in 2011.

See, we still lie!  Are you going to believe us?

Overall inflation deflation was projected to remain subdued increase substantially over the next year and a half.

Fixed it for ‘ya.

Weighing the available information, participants again expected the recovery to continue and to gather strength everything to go to hell and continue toward Lucifer’s cradle in 2011. Nonetheless, most saw the incoming data as indicating that the economy was operating farther below its potential than they had thought, that the pace of recovery had slowed decline had advanced in recent months, and that growth would be more modest during the second half of 2010 Lucifer had been chortling with glee than they had anticipated at the time of the Committee’s June meeting.

Fixed it for ‘ya.

 

Committee Policy Action
In their discussion of monetary policy for the period ahead, Committee members agreed that it would be appropriate to maintain the target range of 0 to 1/4 percent for the federal funds rate.

I threatened them to get them to all fall in line - as soon as they got to Jackson Hole they started talking though.  Bastards.

Mr. Hoenig dissented because he thought it was not appropriate to indicate that economic and financial conditions were "likely to warrant exceptionally low levels of the federal funds rate for an extended period" or to reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. Mr. Hoenig felt that the "extended period" expectation could limit the Committee’s flexibility to begin raising rates modestly in a timely fashion, and he believed that the recovery, which had entered its second year and was expected to continue at a moderate pace, did not require support from additional accommodation in monetary policy. Mr. Hoenig was also concerned that these accommodative policy positions could result in the buildup of future financial imbalances and increase the risks to longer-run macroeconomic and financial stability.

Mr. Hoenig has a brain, and what he really expressed is that the economy cannot stabilize until the excess debt is removed, and that can’t happen as long as the FOMC is tampering with the bond market.  Therefore, until rates rise, there will be no recovery.

We don’t dare print that, however.

Yes, this is all tongue-in-cheek. 

Maybe.

More articles from the Market Ticker….

Even though the overnight interest rate has been stuck near zero for 20 months, are there options available to the Federal Reserve or the U.S. Treasury to bring longer-term yields down further? I have been looking into this question with Cynthia Wu, an extremely talented UCSD graduate student. We present our findings in a new research paper, some of whose results I summarize here.

Our starting point was a framework developed by Vayanos and Vila (2009), who interpret the term structure of interest rates as arising from the behavior of risk-averse arbitrageurs. This model is one way to capture formally the portfolio balance channel that Fed Chairman Bernanke indicated is central to the Fed’s understanding of how nonstandard monetary operations might affect the economy. Vayanos and Vila’s framework has previously been applied to our question by Greenwood and Vayanos (2010) and Doh (2010). One of our contributions is to develop specific measures of how the available supplies of Treasury securities of different maturities might be expected to influence the pricing of level, slope, and curvature risk of the term structure. Although I began as a skeptic of the claim that bond supplies would make much difference, we found pretty strong evidence that historically they have. For example, we found that over the 1990-2007 period, we could predict the excess return from holding a 2-year bond over a 1-year bond with an R² of 71% on the basis of the level, slope, and curvature of the yield curve along with our 3 Treasury supply factors.

One of the challenges plaguing this kind of research is the problem of endogeneity. There may be a correlation between bond supplies and interest rates, but is that because bond supplies affect interest rates, or because the Treasury or the Fed are responding to interest rates in deciding which maturities of Treasury securities to sell or buy? Our solution to this problem is to pose the empirical question in terms of a conditional forecast. Suppose you already knew today’s level, slope, and curvature of the term structure of interest rates, and in addition to those values, I tell you today’s 3 Treasury supply factors. How would the latter cause you to change your forecast of next month’s interest rate for any given maturity? Our finding is that the Treasury factors make a statistically significant contribution across the yield curve.

We can summarize the implications of that forecast in terms of the following scenario. Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years. The figure below summarizes the implied average change in forecast for the 1990-2007 period as a result of this change for interest rates of various maturities. Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points. Yields on the shortest maturities would increase by almost as much. While our estimates imply that the Fed could make a modest change in the slope of the yield curve, it would not make any difference for the average level of interest rates.

Predicted change in next months yields (quoted in annual percentage points) as a function of weeks to maturity in response to Fed converting all its short-term holdings into longest available maturities, average values over 1990-2007. Source Hamilton and Wu (2010).

We then extended the framework to the case when, as at present, short-term interest rates are as low as they could go. Even though short term interest rates have been near zero since the end of 2008, longer term yields have continued to vary from week to week, as shown in the solid lines in the graph below. Our interpretation is that these fluctuations in longer-term yields come from investors’ beliefs that short-term interest rates are not going to be stuck at zero forever. We suppose that investors attach a probability to escaping from the zero lower bound at various future dates, and that, when we do, short-term rates and the rest of the yield curve will revert to a dynamic behavior similar to that exhibited prior to 2007.

Actual (solid) and predicted (dashed) behavior of selected interest rates, weekly from March 7, 2009 to August 10, 2010. Rates shown (in order from top to bottom) are the 30 year, 5 year, 1 year, and 3 month.

We were then able to describe interest rate dynamics since the beginning of 2009 in terms of the historically estimated parameters along with three new coefficients, which correspond to the average short-term interest rate as long as we’re stuck at the zero lower bound, the average new short-term interest rate once we escape from the zero lower bound, and a fixed probability of escaping in any given week. The red dashed lines in the figure above represent the predicted values from this model. This simple framework seems to do a pretty reasonable job of explaining interest rate movements over the past couple of years.

Moreover, the framework gives us the information we need to assess the effects of nonstandard open market operations under a zero-lower-bound regime. The figure below shows how our model implies that the forecasting relation described above would be different under the zero lower bound. The experiment here is the same as before– the Fed sells off all its short-term Treasury holdings and buys an equivalent amount of long-term debt. However, under the zero lower bound, the effect on short-term interest rates all but disappears as a consequence of investors’ beliefs that near-zero short-term interest rates are likely to persist for some time. Quantitative easing– buying the longer-term securities with newly created interest-bearing reserves– would have the same effect in our framework.

Predicted change in next months yields (quoted in annual percentage points) as a function of weeks to maturity in response to Fed converting all its short-term holdings into longest available maturities. Solid line: predicted response over 1990-2007. Dashed line: predicted response in 2009-2010. Source Hamilton and Wu (2010).

Hence our estimates imply that whereas an asset swap by the Fed could not reduce interest rates in normal times, under the present situation, it would succeed in driving overall interest rates lower. To take an illustration, the Fed’s combined $1.1 trillion in mortgage-backed securities plus $300 B in new longer term Treasury purchases might have succeeded in driving 10-year yields 50 basis points lower than they would have otherwise been.

Although our estimates imply that the Fed could do more than it already has, in many ways the U.S. Treasury is the more natural institution to implement such a policy. According to the theoretical framework that motivated our measures of the Treasury risk factors, the average slope of the yield curve arises from the preference of the U.S. Treasury for doing much of its borrowing with longer term debt. For reasons presumably having to do with management of fiscal risks, the Treasury is willing to pay a premium to arbitrageurs for the ability to lock in a long-term borrowing cost. If the Treasury has good reasons to avoid this kind of interest-rate risk, it is not clear why the Federal Reserve should want to absorb it.

But, according to our estimates, if the Fed wanted to absorb more of this risk, it could reduce the slope of the yield curve further by doing so.

The full paper is available here.

Read more….

The global debt crisis and the war on deflation by the Federal Reserve is causing precious metals to approach a key resistance level. Gold is nearing a 52 week high while silver is close to breaking $19. A break above these levels …
Read More…

Read more….