The Housing Market’s Freefall

While the actual damage to the housing market in the near term cannot be totally assessed until later this month, there are some hints in the rate at which purchase applications for mortgages have plunged. The following data is compiled weekly and presented by the Mortgage Bankers Association:

During the past 4 weeks, purchase applications are down a whopping 35%. It is easy to see the spike at the end of April as the end of the tax credit lured May’s (and perhaps June’s too) sales back a month. The downward trend of new purchase applications has continued into June despite very low relative interest rates for home loans. These low rates boosted the Refinance portion of the index during May and remain low, the national average currently at 4.88% according to bankrate.com.

With an upcoming election, we will now likely get the first glimpse at the true state of the housing market. Granted there are still many programs in place at the Fannie/Freddie/FHA level that are encouraging purchases to varying degrees, but it is not likely that direct stimulus through tax credits will be used for at least the next few months. What is very disconcerting is that more than half of the purchasing blitz during March and April was done on the back of government mortgages. Much in the way the government nationalized the student loan business it is now similarly giving the heave ho to private lenders in the mortgage market. These actions virtually guarantee the perpetuation of the distortions currently seen in this critical area.

I had commented, perhaps cynically, to some friends back in 2005 that the housing bubble seemed to be little more than a giant property grab. With government now owning or guaranteeing the majority of mortgages (69 percent), it seems that very well could be the case. Unemployment is still high, decent paying jobs are difficult to come by, and people are still being laid off. Consumer debt burdens are causing the financial hardships endured by many to continue. Repossessions of houses just hit another all-time record high last month. When the government owns the mortgage and someone defaults, who gets the house? Some food for thought on a Friday afternoon.

Retail’s May Swoon

This morning’s retail sales report gave much more cause for concern than any of the recent month’s reports in this area. I’ve dissected these reports on several occasions for our paid subscribers to reveal the biases. Put simply the numbers are not what they seem and haven’t been for quite some time now. The biases, statistical and/or hedonic, tend to overstate retail sales.

Even those biases could not conceal last month’s drop. It is quite likely that the 1.2% decrease in sales was caused in no small part by the ‘Here we go again’ mindset when global stock markets began another round of liquidation. The media had been blaming a late Memorial Day for the potential downdraft in sales well in advance of the release of this morning’s report, which really makes no sense. The drop in sales speaks volumes about the delicate nature of consumer confidence. It is easily shaken these days, and it doesn’t take much. Granted the European (and spreading) debt crisis is a huge problem and will affect us eventually, however, that is not the impression the average person has thanks to the largely absentee media in this country. The crash of 2008, however, is still on people’s minds, and there is a general fear of a recurrence of those conditions. So when the markets act up, people slow spending and increase savings. It is one of the few things we’ve seen in recent memory that actually makes sense. Ironically, the University of Michigan’s consumer sentiment index is telling us that confidence is at the highest level since 2008. So much for our brief trip back to sanity.

The retail sector has not been without its share in the government stimulus binge of the past three years either. Most of the stimulus other than the checks sent out in early 2008 has been indirect, however, the benefits from foreclosure prevention tactics, strategic defaults, and hyper-extended unemployment benefits have perpetuated the spending bubble much in the same way the housing bubble has been prodded along. However, with more and more states such as Colorado and California having to borrow money to pay unemployment benefits and record repos of homes, it would seems likely as though the fuel for this leg of the spending bubble might be petering out somewhat.

Another weight on the consumer is the comparatively higher interest rates on credit cards. According to creditcards.com, the national average for credit cards in May 2010 was 14.31%, up from 12.75% just 6 months ago. So even as banks have been able to borrow from the Fed for essentially nothing, they’ve repaid the consumer for the hefty bailouts by jacking interest rates. Of course the selling line here is that so many consumer loans are in default. Small wonder. Maybe if the underwriting department hadn’t taken 5 years off this wouldn’t have happened.

In summary, the pressures on these two critical markets are increasing as the government’s ability to intervene is hampered by a broadening awareness of its own insolvent state. Granted, one or two months does not a trend make, but we need to be aware of the possible paradigm shift that is occurring – the end of the age of perpetual stimulus.

In yet another example of the failure of globalization, or regionalization as it were, the Euro is poised on the precipice of disintegration. Ironically, it will not be the overprinting and resultant hyperinflationary spiral that kills the Euro, but dead weight in the form of various Eurozone welfare states. Germany and some of the other quasi-responsible members simply cannot carry their own burdens and those of Greece, Spain et al. The $1 Trillion rescue fund created in haste this past weekend was intended to inspire confidence in the dying behemoth. Instead, the sheer magnitude of the bailout has done the exact opposite. The Euro-Dollar pair has now sunk below pre-bailout levels and there is a good deal of doubt as to whether rescue recipients will be willing or able to hold up their end of the bargain. I pointed this out in last week’s piece. The temporary euphoria created by a trillion dollars of palliative paper is already gone. This is something that was alluded to in these pages years ago; the law of diminishing returns applies to stimulus and bailouts. As the periods of crisis occur in a more frequent fashion, the effectiveness of Keynesian monetary policy falls commensurately.

That aside, there are several other points that must be addressed as we examine the latest Tower of Babel in the global macroeconomic arena.

National Sovereignty Ceded

While anyone looking at the debt picture could tell that Greece (like so many others) was in trouble almost since its acceptance into the Eurozone, its problems burst into the international media in early 2010. One of the first things that many people noted was the major difference between the Greek government and that of America. Greece was hamstrung in that it did not have its own national bank; it relied on the ECB. While I am not a fan of national or central banks absent a strict Gold standard, this total absence of flexibility accelerated the Greek crisis in months, rather than years. Greece had given up its national identity to join the Club. And for a time it worked. The people of Greece enjoyed lavish social benefits and a carefree lifestyle. As an IMF official recently said, however, and I am paraphrasing: “The party is over”.
Other dominoes are set to fall as well since every other country in the Club has essentially the same problem: they cannot pay their bills, and have no way to wiggle out of it. While in the strictest of terms, this is not a bad thing; it outlines the categorical failure of international trading and currency blocs in the long run. There are always members of any cohort who will try to ride the coattails of someone else. It is human nature and it will not change. From that standpoint, the breakup of the Club was ordained from the day of its inception.

The mere existence of these multinational blocs also fosters a temporary sense of false security, as member nations don’t mind their own fiscal indiscretions because they have the perception that they’ll be picked up by the rest. And they usually are initially, so why change? This is precisely why the Greek people (and now the Spaniards too) are resorting to riots and national strikes. Old habits die hard.

At the bottom of the mess, however, is the loss of national identity. While we look at them as Greeks and Germans, they have in a way come to view themselves as Europeans – citizens of Europe. As Ben Franklin so eloquently put it, new nations come into the world like illegitimate children; half compromised, half improvised. In the case of the EU, we’ve already seen the compromise. Now the improvisation has begun in earnest.

Destruction from Within

Much in the same way the EU is being destroyed by the profligate spending and lackadaisical approach to fiscal matters of a few members, the United States is in a similar position of being devoured from within. This is where it gets very dicey, and I am bound to step on a lot of toes here, but it needs to be said. We know that roughly half of Americans pay nothing in the way of Federal income tax. While I don’t have exact numbers for the 50 states, I cannot imagine that the situation is much different there. This means that, like the EU, America has roughly half of its population riding the coattails of the other half. I am sure that in many cases there are good and noble reasons why this is the case, but I’m trying to address this from a structural macroeconomic standpoint rather than drilling down to specific reasons why people aren’t paying. Frankly, for the purposes of this discussion, it doesn’t even matter. In this way, America is a microcosm of the Eurozone. And we’re not alone. Great Britain is in the same boat. The bills cannot be paid. There is no way to squeeze enough money from the paying 50% to take care of their benefits let alone those of the other 50%.

Much like the EU, America has a central bank, which advocates Keynesian policies such as deficit spending and unfettered monetary creation. Save for one brief stint of interest rate austerity in the early 80’s, America has never wavered. And before we sing the praises of Mr. Volcker, we must consider that his actions most likely were taken to perpetuate the broken system as a whole as opposed to representing some blanket metamorphosis of economic thinking.

The single biggest difference here is that the members of the Club still have the ability to vote others off the island, and/or leave themselves. There is a point certain where the people of Germany, for example will no longer tolerate the abrogation of their economic and financial sovereignty and will either compel Ms. Merkel to take appropriate action or will replace her with someone who will. Hence all the talk of the breakup of the Eurozone. The die was cast on January 1, 1999 when the Euro officially became an international unit of account.

Race to Gold – the Endgame of Paper

All the gloom and doom aside, there is an out for those countries and individuals who fear the breakup of the Eurozone, dollar standard default, national bankruptcy, and the types of cataclysmic financial events that our behavior causes us to flirt with. It is shining right now, making new all-time highs as I pen this commentary. It is soaring even as the dollar races higher thanks almost entirely to the fall of the Euro. The mini liquidation last week in global markets was unable to shake it, so unlike the Lehman days in 2008. People around the globe are racing to Gold as the ultimate safe haven. Where the US Dollar is a proxy on the flaws of the Euro, so is Gold the ultimate proxy on the fallacy of stable paper currencies in a Keynesian world. Where paper currencies represent control, Gold represents freedom and a standard weight and measure.

This is probably one area where many here in America fail to understand the connection between our wallets and the first round of the Eurozone bailout. Thanks to our contributions to fund the IMF, and the resumption of various Fed emergency swap programs, the American taxpayer is on the hook for more of the European rescue fund than anyone who seeks to maintain their position in politics or finance is willing to admit. The burdens of lesser paper currencies are shifting to the already compromised US Dollar and the American taxpayer. There is nowhere else to turn except honest money. Truly, the buck will stop there.

One of the biggest ways our premium newsletter has benefitted its subscribers over the past few years is comprehensive analysis of the macroeconomic, monetary, and precious metals environments. In May’s issue, which will be released on 5/15, we cover the conventional wisdom surrounding sovereign debt loads, propose some alternate metrics, and look at the latest jobs figures. For more information, click here.

The ‘Strong Dollar’ is Back?

For the past several weeks, the proclamations of a ‘strong dollar’ have been floating around the airwaves. Commentators will point at the rising USDollar Index and mistakenly assume that everyone wants our currency because our economy is recovering so nicely. What they fail to understand and/or convey is how the index is calculated. The index is nothing more than a weighting of the value of various currencies versus the Dollar. The Euro is currently 57.1% of the index and is in freefall thanks to out of control sovereign debt. Our policymakers should be taking notes on the developments in Europe. At any rate, since currencies are traded in pairs, when one half of the pair falls, the other rises. This recent surge in the US Dollar index, while good for us in terms of the cost of European imports has nothing to do with the strength of our currency. I’ve said this time and time again. We have to hope for bad things to happen to the rest of the world to keep the Dollar afloat. The true barometer of the strength of a currency is the cost of Gold in that currency. Even as the Dollar index has risen over the past several months, Gold priced in Dollars has risen right along with it. Gold is sniffing out exactly the points made above. People are fearful of paper currencies, and while they dump the Euro in favor of the Dollar in the short run, they are also loading up on Gold, the ultimate money.

The reality shown above is not a one or two day event, but a three month trend, which is intact even in a period of extreme market distress. Many people will try to draw parallels between 2008 and the present. By that logic, they argue that Gold should be falling since we’re flirting with another period of all-out liquidation. However, 2008 was largely a liquidity crisis whereas today we are facing that plus the bankruptcy of roughly 20 nations and the possible disintegration of at least one currency along with it. Yes, the sovereign debt crisis is that bad. Granted, the emerging divergence between the equity markets and Gold (shown below) is in its infancy, but it is a very important development and needs to be pointed out now.

Will Greece Pay Up?

On the front burner and driving the current hysteria is the situation in Greece. While the EU has come together to bailout the embattled nation, there are legitimate fears that:

a) The bailout isn’t big enough and is merely a band-aid. Apparently folks have been paying attention to the bailout of the US financial system.

b) The EU won’t be willing (or able) to extend the bailout

c) The people of Greece will not accept austerity measures

d) The people of Greece will dismiss their standing government in favor of one who will continue the current welfare state.

e) Greece will not pay back its neighbors for the bailout

I would contend that all of these are legitimate concerns. Several days of intense rioting and national strike by the people of Greece are making it very clear that at this point they have no intention of being under the thumb of austerity. This is what happens when you create a welfare state. Again, our policymakers should be taking notes. The country can’t pay back what it already owes, hence the ‘need’ for a bailout. How is a reasonable person to accept the notion that somehow Greece will now be able to pay back the money already owed plus another $146 billion in bailout loans?

Yanking the carpet out from under a welfare state is going to have monumentous social implications. The people of Greece are likely to dispatch their current government in favor of one who will take a disposition similar to that of Iceland and tell the lenders of the bailout money and the country’s creditors in general to take a real long walk off a short pier.

It would be bad enough if this problem stopped at the Greek borders, but unfortunately, it is nearly systemic in Europe, and in fact extends across the Atlantic as well.

Freddie Mac Continues to Bleed

In a harsh reminder of the perpetual state of bailout that the US has entered, Freddie Mac announced earlier this week that it will need another $10.6 Billion from the Treasury by the end of June to cover first quarter losses of $6.7 Billion. This wil run Freddie’s tab to well over $50 Billion with no end in sight.

Back in 2008, the USGovernment pledged to guarantee that both Freddie and Fannie Mae maintain a positive net worth. This has led to periodic infusions of cash into what is now admitted to be a black hole at both companies. What is most concerning about these actions is that there is little or nothing being done to end the reliance on bailouts. At the root of this problem lies the reality that people, for various reasons, cannot pay their mortgages. For many it is because of job losses. If we’re going to borrow and throw money down a black hole, it would have made a lot more sense to use the $50 Billion to build some factories that would employ workers who would produce goods made in the US. That would have put people to work and at the same time would have helped us ease our reliance on foreigners. Instead, we throw the money away, choosing to perpetuate a broken system.

April Jobs Report

As of this writing, the April jobs numbers are available. The economy ‘added’ 290,000 jobs in April, with generous upward revisions to both February and March. What is disconcerting about this report is the fact that we now know that roughly 600,000 new census workers are in place, yet these folks don’t appear to be attributed to the government’s portion of the non-farm payroll. BLS is claiming that of the 573,000 jobs created so far this year that 483,000 were created in the private sector. Yet looking at the Federal Government’s workforce over the past few months there hasn’t been much of an increase at all. So either government is trimming the sails in other areas or the census workers aren’t being counted as government employees, but are instead being credited to the private sector. A recent Gallup survey seems to bear out this discrepancy in that it concluded that government hiring was outpacing private sector job creation. While we don’t yet have the birth/death adjustment to April’s numbers, it is clear that something is amiss. The headline and U-6 unemployment rates rose to 9.9% and 17.1% respectively. State and Local government workforces continued to shrink in April, outlining the dire circumstances that continue to face many geographic areas.

With the cost of insurance on European bank bonds surging to a pre-Lehman high, it is apparent that at the very least, there is again a severe ripple in the credit system, this time at a sovereign level. Given debt levels around the globe it is quite likely that damage control will take precedent over containment.

Probably the most misleading of conclusions is to simply point at the national debt and declare America to be bankrupt. While there is no denying that America is in big trouble with its national debt that will not be what causes bankruptcy. Think of it on a micro scale – a family. Family X has $120,000 per year in revenues and $150,000 in expenses. Let’s say for the sake of simplicity that the family replicates these figures for 4 years. At the end of the 4 years, Family X’s debt (not counting interest payments) will be 100% of its revenues. Is Family X bankrupt? Absolutely not. Truth told, this family could continue to run these annual deficits as long as someone is willing to give them $30,000 in loans each year, dismissing debt service payments for simplicity.

For some reason when it comes to looking at Sovereign debt and debt ratios, the number always used as a benchmark is GDP. I am uncomfortable using GDP in creating a quantitative measurement of solvency since GDP is not some cash account from which public debt may be paid off. GDP is a rather convoluted measure of output, not an expense account. Since the Federal government has assumed this debt on behalf of you and I (a whole OTHER issue), they (we) are responsible for paying it back. Therefore, since the government is on the hook, we need to be looking at the government’s revenues, not GDP when making judgments on the veracity of the government’s financial position.

In fiscal year 2009, the US Government had revenues of $2.198 Trillion. This was a decrease of $463 Billion from FY 2008 according to the Treasury’s Financial Report of the US Government report. The outstanding debt as of this writing is $12.87 Trillion making the debt/revenue ration 5.85. This is a whole lot worse (and much more accurate) than saying that debt is 90% of GDP. As bad as it is having an outstanding debt that is roughly 600% of revenue, it doesn’t even begin to address the issue of bankruptcy.

Marginal Utility of Debt Turns Negative

The underlying graphic has been seen in many different places, and with good reason. One of the biggest justifications of borrowing money in any situation is to cause growth. What has become apparent, however, over the past 5 decades is that the utility at the margin has diminished. What this means is that our ‘bang for the buck’ has disappeared. For example, back in 1966, a dollar of debt resulted in nearly $.90 in GDP growth. Today, adding a dollar of debt results in an over $.40 contraction in GDP. While this doesn’t have a direct bearing on national bankruptcy per se, what it is telling us is that our borrowing addiction is now cannibalizing economic growth. Small wonder. However, since economic output has a direct bearing on government revenues vis a vis tax receipts, the broken debt function will sit like an albatross upon our backs as we try to negotiate this brave new world.

We see evidence of the recognition of this reality in Washington as policymakers of varying stripes try to justify a value-added tax to close the gap and give the impression that we are, in fact, serious about austerity. No, this isn’t a joke. As usual, our government is making more colossal mistakes. Of course, real austerity would mean cutting government spending, but it should be clear to all that we will get nothing of the sort; from either bunch.

So, What Exactly is it that Constitutes Bankruptcy?

According to the Kotlikoff-Auerbach model, which is a variant of Irving Fisher’s Two Period Life Cycle Model work circa 1930, the current fiscal gap is approximately $185 Trillion. That number is a week old. Back in July of 2006, the fiscal gap stood at $65.9 Trillion. Anyone see a problem here? This gap analysis includes the full complement of social insurance programs including the new healthcare plan, military spending on wars for global empire, other domestic entitlements, and pretty much anything else you can think of that the Federal government might be involved in. The model looks at future revenues and outlays well into the future using current law and policy and uses the Net Present Value equation to bring the future amounts into present dollars.

To what extent will the Federal government be able to take the output of producers in the economy and dedicate it towards payment of these bills? We were cutting it very close when the number stood at $65.9 Trillion 4 years ago. Instead of addressing it then, we chose to do nothing. $185 Trillion is an unfathomable amount of money, especially for a government that takes in around 1/90 of that each year in tax revenue. And it is a lot for a country, whose total assets don’t even amount to 1/3 of our tab. Simply raising taxes won’t do it. The more marginal tax rates rise, the less incentive there will be to produce in following the old economic wisdom that you always get less of what you tax and more of what you subsidize. The historical landscape is littered with examples of how raising marginal tax rates actually causes tax revenues to decrease. So much for the idea of the VAT saving the day. Taking corporate profits won’t do it either. Raise taxes on corporations and they’ll lay off more employees, raise finished goods prices, and consumption will fall in proportion. So that isn’t going to work either.

An Undesirable Solution

The only real solution to this mess would be to essentially kill off Social Security, Medicare, and Medicaid benefits beyond what those programs actually take in each year on a cash basis. Going hand in hand would be the assumption that the contribution rates of these programs would remain the same. Pay 85% of benefits based on what the forecast is for the program’s revenue for a year, then give recipients a ‘catch-up’ payment at the end of year based what was actually taken in. Then start the next year with a clean slate. No unfunded liabilities. Period. At the same time, government would be turned into a flying gas can, being allowed to spend on only the barest of essentials.

Can you see the myriad of problems that lie in such a course of action? Forget the fact that it would be political suicide for anyone to propose this, which is the only reason I can get away with it – I’m not running for office. The culling of government would result in massive unemployment, with essentially no way to pay the benefits. The same would be true for private sector unemployment. The program cuts in social insurance would put most families over the edge since so many people rely on them. Ostensibly, we have no savings as a nation, with more than 4 in 10 having less than $10,000 set aside for retirement or any type of life emergency. In short, too many people rely on these programs making the social insurance Ponzi scheme too big to fail. At the same time, the sheer magnitude of these programs makes them too big to save.

Fundamentally, the question of American bankruptcy (or any for that matter) becomes the simple matter of looking at the bills that need to be paid and determining if they can in fact be paid. They certainly can’t be paid with revenues; we know that. We are already borrowing heavily and there is no indication that will change. Getting back to the earlier example of Family X, conventional analysis keeps telling us that some time uncertain, such a system arrives a point where there is simply not enough money in the system for external lenders to perpetuate it.

Points to Ponder

For all intents and purposes that has already in fact happened and the Fed is currently monetizing roughly 80% of Treasury auctions and bribing banks NOT to lend to the public by paying them interest on the reserves they keep at the Fed. This is all done to avoid what would normally turn into a hyperinflationary explosion. The bills cannot be paid. America is bankrupt. And we’re not alone. This is one of the reasons I wrote two weeks ago that we’re going to likely see a coordinated devaluation of currencies and then default as central banks slam the door on monetary creation. The monetary aggregates are already showing signs of this. It will not be pretty. At the same time expect more cuts in programs like Medicare, Medicaid, and Social Security. The money will simply not exist to pay all the promised benefits. It will be an in situ default.

There will be those who will say that the above thesis is baloney and that it will be hyperinflation forever and ever. We are so much smarter than we were back in the 1930’s and we should have never allowed that nasty deflationary collapse to occur. However, the debt bubble that exists today on a global scale is several orders of magnitude larger than what existed back then and believe me, banks and governments knew back in the 1930’s about over-issuing paper currencies.

Our national history is littered with these little experiences of wanton money creation. They never ended well. However, looking at it through that lens, the 1930’s allowed the banking elite to ‘reset’ the system and squeeze another 70+ years out of an already broken monetary model. However, the only reason we made it this far is because the first 30 or so of those years we were giving away the national treasure in the form of our Gold to foreigners for the right be the consumers of the world. History doesn’t always repeat, but it sure does rhyme. I certainly don’t have a crystal ball (or inside info for that matter), but to me, the above thesis makes a good deal of sense especially given the untenable financial position we find ourselves in.

We already have what amounts to the sovereign debt equivalent of a commercial signal failure in the case of Greece, and it doesn’t take much thought to come up with the conclusion that nobody wants to step up and bail out an entire country and start the avalanche. It may well end up being that the default occurs for no other reason than it is the path that provides the least resistance.

All joking aside, we’ve again reached the point of absurdity on so many fronts that instead of focusing in on a single topic, it is time to dedicate an entire issue to scanning the landscape in an attempt to make sense of the ludicrous.

Bureau of Labor Statistics – Ring #1

The monthly unemployment numbers were released last Friday by BLS and you could almost hear the clinking of the champagne glasses from the studio in the belly of the NASDAQ. Yes, the US only lost 36,000 jobs in February; good times must be just around the corner! Such a sham was this report that I actually dedicated an entire podcast to debunking it. The bottom line is that the jobs deficit for the month of February was around 350,000 jobs – nearly 10 times what BLS reported. This takes into account the 97,000 jobs mysteriously created by the birth/death model (completely unsubstantiated), the fact that our economy needs to create roughly 145,000 jobs each month just to break even in terms of population growth and new entrants to the work force, and finally the fact that most of the ‘new’ jobs created were temp jobs, a whole bunch of which were for the upcoming census.

Perhaps the most alarming part of this report was the revelation that 31,000 state and local government workers lost their jobs last month. These are the jobs most people make fun of, but would love to have because they’ve always been considered to be a job for life with a great pension. The paradigm is changing folks. Either recognize and deal with it or become cannon fodder for the new economic realities that are emerging. The days of borrow and spend are over; at least for the consumer. As you’ll see in the next section, the US Government apparently thinks it has an exemption from the laws of economics – and common sense.

The US Treasury – Ring #2

In the second ring, we have the US Treasury and its burgeoning FY2010 shortfall. So bad was FY2009’s shortfall that the report that outlines our actual financial position was delayed nearly 2 full months, FINALLY being released back on 2/26 to an absolutely comatose response from the belly of the NASDAQ. February’s outlay was massive, totally $220.9 billion. Much of it was blamed on stimulus spending, tax credits, and TARP outlays of $2.3 Billion (Yes, they’re still handing out TARP money). The media cooed about the Fed’s contribution to the US Treasury, but says nothing about the fact that every dollar in our system is loaned to us by those same loan sharks at interest. Ah, the conveniences of selective reporting. To date, the Treasury’s gap stands at a whopping $651.5 billion, which is around $65 billion ahead of last year’s record pace. If they maintain this pace for another seven months, we’ll have a cash basis shortfall for FY2010 of $1.563 trillion – around $132 billion more than FY2009.

Let’s consider for a second all the money that has been spent on stimulus and other projects. Let’s consider the trillions spent bailing out banks. Finally, let’s overlay all that spending with the grossly awful jobs report from last Friday and the months preceding it. How can anyone in their right mind call the stimulus anything but an abysmal failure? The problem is that the government cannot create jobs. Simple. Yes, the government can pay people to perform services. They can pay for a guy to fill potholes. (Send someone to Pennsylvania while you’re at it please; I’ve seen some potholes here that are bigger than these new ‘mini’ cars everyone seems to want.) Once the potholes are filled, then what? Once the bridge is built, then what? Once the census is finished, then what? It all comes down to sustainability. None of the money that is being spent in ‘stimulus’ is being spent on anything that can sustain itself. It cannot pay for itself. How is an $8000 housing tax credit going to pay for itself? The consumer will take the $8000, spend it and create a temporary boost. Then what? This is why I’ve said for many months now that additional stimulus would be needed. And it will need to continue ad infinitum unless our policymakers wise up and start implementing policies that would foster genuine growth, provide for a return of manufacturing to the US, and create sustainable economic growth. Unfortunately, that just isn’t in the ringmasters’ plan. The new tactic in Washington is to devise stimulus packages, but call them anything but, as if somehow changing the name really makes a difference.

The Commerce Department – Ring #3

Not to be outdone we have the Commerce Department, and more specifically the Census Bureau, in the third ring. This morning’s release of retail sales data will no doubt serve to thoroughly confuse anyone who pays attention to such matters. Granted, it is extremely hard to reconcile, but one must look just in the opening statement of the release to get a window into what is really going on here. Repetition notwithstanding, it must be noted (again) that retail sales are reported in nominal terms. From this morning’s release:

“The US Census Bureau announced today that advance estimates of US retail and food services sales for February, adjusted for seasonal variation and holiday and trading day difference, but not for price changes, were $355.5 billion…”

It would be much more useful, albeit challenging to accomplish, if these numbers were reported in units as opposed to dollars. But we can do some reasonable discounting on our own. The ‘headline’ retail sales number was up .3%. Ignore for a second that the media takes sales ex-autos when that shows a bigger gain or smaller loss. Basically, whichever number is better is the one they’ll focus on. While we don’t yet have February’s CPI, let’s assume the headline is .2%-.3%, which is pretty much in line with what has been reported over the past half year. That pretty much wipes out the headline gain. Our internal metric was .55% for February, which when applied to the headline number would take it to a .25% contraction.

Of course, you’ll never hear this from the belly of the NASDAQ. You’ll be lead to believe that all is well, consumers are tripping over each other to spend money, and that a return to the boom times of 2005 can only be a few short months around the corner. While that would be nice, it would be extremely irresponsible to predict such an occurrence based on the evidence that now lies before us.

Some potentially useful tidbits of information from the report are presented below. It must be noted that these useful bits of information can be gleaned from each month’s report for monitoring purposes.

- Seasonal Adjustments added $38 billion or 12.28% to February’s total.

- Removing the seasonal adjustments, retail sales fell in February from $321.8 billion to $316.7 billion; a change of $5.1 billion or 1.59%

- Gasoline station sales are up 26.4% in the last year.

- The 3.7% jump in electronic and appliance stores comes in concurrence with several states doing ‘cash for appliances’ type programs. See Iowa as an example. The state gave away nearly $200 million in funds to such a program. While that may not sound like a lot, it accounts for nearly all of February’s gain for the sector. And that is just Iowa. I realize this is highly anecdotal in nature, but these are the types of things that can skew reporting and promulgate false assumptions so I’m bringing it up.

- The data for MARTS (Monthly Retail and Food Services Survey) is gathered by sending surveys to 5000 businesses. The responding firms’ data accounts for nearly 65% of the national monthly sales estimates.

- The estimates use the 90% confidence level. If the range established by the use of this level includes zero, then the change is not statistically significant. The headline number was .3% with a range of ±.5%, meaning that zero lies in the range, and therefore this month’s retail sales change from last month is not statistically significant. The December 2009 – January 2010 change of .1% with a range of ±.3% was also not statistically significant. Put simply, retail sales are just as likely to have been flat or even negative as they were to gain .3%.

Obviously the points above are enough to cast serious doubt on the veracity of consumer spending. When one overlays the jobs situation, relatively stagnant incomes, and other factors over top of this, it would seem fairly likely that this report represents something of an outlier. It is also instructive to note the role that borrowed government spending plays in skewing the numbers as in the case of cash for clunkers last year, homebuyer tax credits, and now cash for appliances. Also not commonly known is that Medicare spending also counts as part of retail sales. So if Medicare pays for a knee replacement for your uncle, that counts as retail sales and is parlayed as consumer spending.

Sorry Ringling Brothers, but the government-media complex, which puts out and then appropriately spins the numbers and information has stolen your title of “Greatest Show on Earth”; and they’ve done it hands down.

This month’s issue of the Centsible Investor will be released on Monday, March 15th. It will contain an in-depth analysis of the recent Treasury report on the financial condition of the US, a look at current trends in gasoline production and consumption in light of predictions of $3.50/gallon gas this summer, and a comprehensive study of a rather successful petroleum transportation operation. Plus, we’ll do our usual cutting-edge analysis of the major stock indexes and plot the course for the markets over the next few weeks. For more information, Click Here

What does this mean? It means more reliance on foreigners for everything from food to fuel, to consumer trinkets. It means larger trade deficits (since you can’t export government – although it would really be nice to export the whole doggone thing right now!), and further pressure on the US Dollar.

Theme #1 for 2009 – The blowout federal deficit

“In a classic journalistic transgression, the Congressional Budget Office stole most of the thunder of our first theme for 2009 – a blowout in the Federal deficit as the government, almost out of options, pulls out all the stops and piles it on taking the national debt curve parabolic.”

I’ll readily admit I should have spent some more time on this, but the CBO had in fact just released a report on the projected 2009 FY budget that was actually carried in a spirit of journalistic honesty unrivaled in recent years. The media, for a week, became deficit hawks. After that they resorted to just gawking at the monthly Treasury shortfalls and commenting how it was ‘necessary’ to get the economy going again. The ending FY 2009 deficit was indeed massive: $1.4 trillion.

This year, we’re in a similar situation; the CBO came out this week with a report identifying a $292 Billion shortfall for the first two months of FY 2010. If this trend holds out, the FY 2010 shortfall would be in the $1.75 Trillion area. I’m inclined to go even higher and predict a greater than $2 Trillion deficit for several reasons:

1) Another stimulus is in the works. Reeking of Madison Avenue marketing, this third stimulus in just two years is not even being called a stimulus, but a jobs plan. If you read the fine print, however, you’ll see that it differs very little from its most recent predecessor. While details are sketchy at this point, I’ve been asserting for the past few months that they’d propose another stimulus and it would be a whopper: probably a trillion dollars or more. I’m sticking to my guns on this one.

2) The actual ‘cost’ of the existing programs is much higher than their price tags, resulting in a dramatic and spectacular piling up of shortfalls. For example, the 2009 stimulus carried a $787 Billion price tag, but a total cost somewhere in the neighborhood of $3.25 Trillion according to the CBO.

3) Healthcare Takeover. Again, details are sketchy at this point, but the nationalization of America’s healthcare system is likely to sport a price tag of near a trillion dollars, with the actual cost likely somewhere between here and Saturn since it is not a one-time program, but one that will run essentially in perpetuity. Don’t be fooled by assertions that this measure will prevent the insolvency of Medicare and Medicaid either.

All of these factors (and many others) point to a continued increasing slope of the public debt curve. Not to mention that at this point in the debt curve, which is essentially a mathematical function, deficits beget larger deficits as compounding kicks in. Another buffalo nickel goes out to whoever accurately predicts the year when we cross the $100 Trillion mark on the national debt. In truth, the currency system we’re under may well end before we reach that point, but it is an interesting study nonetheless.

Theme #2 for 2009 – States Circle the Wagons for bailouts

“California, New York, and as many as 29 other states are already in fiscal extremis as revenues plunge due to unemployment and decreasing tax receipts. States are faced with difficult choices in 2009. They can raise taxes, cut services, beg for a bailout, or in all likelihood all of the above. And in a typical ironic twist of fate, the market for municipal bonds is drying up just when the states are going to need the money most. To make matters worse, yields on municipal bonds blew out to nearly 2.2 times the yields on corresponding Treasury issues. This is more than twice the .96 historic level normally observed. Obviously, the message here is that the perception of security is gone. We pointed out this likely eventuality when MBIA and AMBAC came under duress and saw their credit ratings cut back in June. Not only are the bonds questionable, but their insurance is as well. The bottom line here is that if bond issues can be sold, investors will command much higher yields resulting in greater debt servicing costs. Initial forecasts for 2009 indicate that there will be a 6% decrease in new bond issues sold, taking the total down to around $364 Billion.”

Again, absent Madison Avenue marketing, we’d have seen this for what it was. The 2009 stimulus was largely a de facto bailout for many states that lined up to grab the federal dollars. However, several spurned the freebies in heroic fashion, realizing that there were too many strings attached. Granted, not much has been made of the downgrades of AMBAC and MBIA since they happened and on top of that muni bond yields have fallen so much that on many points along the yield curve, they’re actually bringing in less than their Treasury counterparts. However, if you adjust for the 28% tax rate equivalent yield, muni bonds are still sporting a hefty spread at the long end of the yield curve: 1.42X the 30-year Treasury bond.

As for the issue of cutting services and raising taxes, we were spot on. The media landscape in 2009 was littered with stories of cities, states, and municipalities cutting all sorts of services, even police, fire, and EMS in many cases. New Jersey, California, and Michigan were just a few states that gave public school teachers pink slips in 2009; a nearly unprecedented move. On the revenue side, many areas have resorted to increasing and adding fees as opposed to raising funds through the more traditional taxing systems already in place. NYC led the way in this regard, raising fees on everything from parking to taxi cab rides. And the rest of us haven’t been immune either. Fees and surcharges are being raised all over the country in an effort to patch broken budgets from Omaha to Oregon without raising broader tax rates, which are much more in the public eye.

The one portion of the municipal story that we seem to have been a tad early on is the overt purchase of muni bonds by the government. However, given the fact that California virtually begged the Treasury for TARP money and the Treasury’s CPP (Capital Purchase Program) has poured over $26 Billion into California banks, it is probably not a completely unreasonable assumption that at least some of that money went towards California ES and GO bonds held by the aforementioned banks.

Theme #3 for 2009 – Creative Financing to Induce Borrowing

“Creative financing will be back in 2009. And I don’t just mean 0% interest loans. Any machination that allows payment to be put off until a later date will do. 12, 24, and 36 months interest-free. No payments for 12 months. Partial payments for 12 months. No down payment and we’ll make the first 3 monthly installments for you. We’ve already seen these before, but they’ll become commonplace in 2009. Look for new ones as well with longer payments terms, which ironically means you’ll end up paying even more for the items. However, the focus will be on the ‘low monthly payments’. Stimulus checks may not be checks at all, but may rather have a requirement for consumption attached. All indications are that the framers of the last stimulus package were unhappy because not enough of the money was spent. Apparently some people actually paid bills and/or saved the money. Maybe Wal-Mart and Home Depot Gift Cards will be the delivery method for the next economic stimulus. I’m only half joking about this.”

Cash for Clunkers. Need I say more? On other fronts, the Fed has led the charge to induce home buying through the purchase of $854 Billion (to date) worth of mortgage bonds. Not to be outdone, the feds have thrown in their own incentive in the form of tax credits for first time home buyers. These folks will do anything to raise the dead and buried notion that home ownership is the epicenter of wealth and prosperity. There have been various incentives to purchase all manner of home improvements centered on energy efficiency. This might be perhaps the most innocuous of the government’s attempts to urge people to spend money. We were spot on with regards to cash handouts; they didn’t happen because the government wants to guarantee that people actually spend the money. So instead of mailing checks, the feds will give you a kickback if you spend your own money or even better, borrow and spend someone else’s.

Retail chains have done their part by slashing prices to induce spending. Creative financing arrangements are out there, but are not quite as prevalent as we had expected at the outset of the year save for the auto sector. Consumer spending has remained tame at best, and the consumer’s willingness to take on more debt to finance large living has diminished significantly. Consumer credit outstanding – one of my favorite indicators in terms of predicting consumption patterns and GDP growth ex government spending has seen 8 consecutive months of declines; the first such occurrence of a sustained decline since the series began in 1943. The mainstream has of late picked up on this storyline mostly because the declines in recent months have been less severe which fits into the mantra of ‘not as bad’ economic reports being spun as great news.

For sure as we close out the first decade of the new century and millennium, the spin will be on the increase. Few things will be as they appear. News reporting has already taken on a frighteningly 1984-ish aura complete with glitzy marketing props and plenty of subterfuge. Economic statistics released by the government will become more and more irrelevant. Even now, press releases from BLS and the Commerce Department in particular are littered with asterisks about changes in reporting, methodologies, and data gathering. It would seem those responsible for providing us with accurate data have hired the Enron crew to cook the numbers for them.

You can have all of this spin and subterfuge decoded for you each week on ‘Spin Cycle’. I host the show and debunk economic reports and bring on guests to talk about the important issues of day as they relate to media bias and misinformation. For more information or to listen, please visit Contrary Investor’s Cafe

Cost vs. Price

It would probably be rather hard to find a single American that didn’t know the price tag of the stimulus bill. $787 billion has been included in nearly every news piece regarding the topic. What most people are not aware of, however, is that $787 billion only represents that amount of money actually put into the economy by the feds. It comes nowhere near addressing the actual cost of the program. A good recent example of this miracle of government accounting is the Medicare part D prescription benefit program. The price tag was $394 billion, but the cost is much higher – around $8.7 trillion and counting depending on which numbers you want to use. Granted this represents the net present value of the cost of these ongoing benefits over a 75-year period, but you get the idea.

Fortunately for taxpayers, the stimulus package is not an ongoing expenditure (yet), and as such consists of predefined outlays. Despite this, the total cost of the bill as compiled by the Congressional Budget Office is approximately $3.27 trillion. Amazing in this is the fact that we’ll pay nearly as much for debt service on the stimulus bill ($744 billion) as the measure was supposed to provide to the economy! Talk about sticker shock. The gory details are here.

The question now becomes one of return on investment. What exactly are we going to get for our $3.27 trillion? It had better be good too, because nearly all of it is borrowed from someone – either foreigners or the Fed. Unfortunately, such is not the case. Using the $3.27 trillion projected cost, the ROI for the stimulus bill stands at a whopping -415%. In the private sector, such a revelation would result in a project being killed instantly in the concept phase. Not so in the hallowed halls of Congress where the laws of economics and common sense do not apply.

A Good Deal for Taxpayers?

We have been assured in almost doublespeak fashion that the stimulus bill was necessary, and was in fact, a good deal for the American taxpayer and would create or save millions of jobs.

The ballyhooed cash for clunkers program deemed such a success ended up costing taxpayers around $24,000 for every car sold under the program. This when the actual benefit to the buyer was only $4,500. Some other examples, courtesy of AP, include:

- A company working with the Federal Communications Commission reported that stimulus money paid for 4,231 jobs, when about 1,000 were produced.

- A Georgia community college reported creating 280 jobs with recovery money, but none was created from stimulus spending.

- A Florida childcare center said its stimulus money saved 129 jobs but used the money on raises for existing employees.

One disconcerting admission in the past week came from Christine Romer, the head of the Council of Economic Advisors. She stated that the largest impact from the stimulus had already been felt and that moving forward, the stimulus would only serve to prevent the economy from slipping further rather than contributing to any growth. Sounds like a recovery eh? It would sound as if Ms. Romer is already laying the groundwork for the next brainchild of economic ignorance: Stimulus – The Sequel. Here are her quotes:

“By mid-2010,” she said, “fiscal stimulus will likely be contributing little to further growth.”

“While job losses will likely end early next year, robust job gains may still be several quarters away,”

“This is not a normal recovery, Coming out of this, we’ve got lots of things working against us.”

Like the laws of economics for starters?

What also must be noted is that the federal deficit alone for FY 2009, which doesn’t included net present value of unfunded liabilities, was $1.4 trillion. The fact that such a large sum of money had to be spent to prevent an all-out collapse of the US economy should be alarming to anyone with a pulse. The fact that current projections are for $1 trillion plus deficits annually for the next ten years should curl your eyebrows.

Let’s assume for a minute that Ms. Romer is correct and that we’ve seen all the bounce we’re going to get from the stimulus. According to AP, the number of jobs created directly by stimulus spending was around 25,000. Sure, there are probably some others that slipped through the cracks and it is very likely that some firms held off on layoffs because of the temporary burst of cash. But lets look at the cost of those jobs JUST in terms of the debt service created by the stimulus bill. Each of the 25,000 jobs created cost the taxpayer $29,600,000 in debt service alone.

Keep in mind that unemployment has been going up constantly during the time when we were getting the maximum ‘benefits’ from the stimulus. As soon as the money wears off, firms will fall back on their original plans, which include cutting back on staff. Another stimulus package will be needed – and soon – to stave off the infamous double dip that many economists and commentators have long been forecasting. The proverb that a house built on a rock will weather any storm, but one built on sand will certainly collapse rings very true in our current state of affairs.

The real question that needs to be posed to anyone supporting additional foolish stimulus needs to focus on an exit strategy. How will additional stimulus create a foundation for fundamental, healthy economic growth? The short answer is that it won’t, but lets make them answer anyway.

It is therefore worth chronicling his recent reversal on the prognosis for the US economy. Long known as a ‘bear’ and as recently as June 15th skeptical of Helicopter Ben’s ‘Green Shoots’, Roubini now sees ‘light at the end of the tunnel and for once, it is not a train’.

It is hard to understand how any economist who looked at our broken system in a proper enough fashion to predict what has happened over the past 18 months could suddenly come to a different conclusion given that virtually nothing has changed – unless you want to count the exacerbation of many of the problems which got us into this mess to begin with.

How could persistent multi-trillion dollar deficits, more intrusive government policies, the apparent guarantee of additional tax burdens, debt monetization, and higher than expected unemployment numbers (even the watered down BLS numbers are above administration and Fed estimates) cause someone of Roubini’s intellect to suddenly change his mind and see green shoots instead of yellow weeds?

Whatever the reasons were, the markets loved it. The DOW continued its winning streak, dragging the NASDAQ and S&P500 with it. Interestingly enough, the Wilshire 5000 did not exactly follow suit, actually losing ground at the end of the day while the benchmark indexes gained.

This is just another bit of anecdotal evidence that the rally from March 6th has nothing to do with green shoots for the broader markets and the economy, but rather resembles Jack’s beanstalk. And we all know what happens when you play with magic beans.

Added from Roubini’s Blog on 7/16:
“It has been widely reported today that I have stated that the recession will be over ‘this year’ and that I have ‘improved’ my economic outlook. Despite those reports – however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.”

If you go to the NYSE website, you will be able to find what is called an Industry Classification Breakdown or ICB. There are ten major industries with varying numbers of supersectors, sectors, and subsectors under each major heading. Now let’s say for example, in your reflections on what the major economic and investing themes happened to be that you zeroed in on consumer staples as an area that is positioned for success. At this point we are assuming that you’re not interested in just finding an ETF or Closed-End Fund that gives exposure to firms that produce consumer staples, but are interested in becoming more acquainted with some of the individual firms themselves. Once you have performed your basic analysis, you’ll know which firms you’d want an ETF or other Fund to include or can purchase them outright and will be an informed shopper so to speak.

That said, when you go to the ICB listing for Consumer Goods, you will find the following:

Clearly you are not interested in examining all of these areas. Your focus as decided above is on staple goods. Immediately, the broad category of Leisure Goods can be eliminated. Automobiles can probably be eliminated as well if we’re focusing totally on staples or necessities. This leaves a wide sampling of categories. For the purposes of this discussion and in the interests of brevity, we’ll limit our analysis to a single sub sector – Food Products.

Before we continue, some limitations of this search methodology must be identified as well. The NYSE search is only going to show the firms that are listed on NYSE. It will not show international firms that are listed on other major exchanges, but not on the NYSE. The good news is that many of the larger firms are dual-listed. The bad news is that by limiting your search to only NYSE-listed issues, you will likely miss some good possibilities. Many of the other major exchanges such as the TSX also have similar search capabilities and by spending a little time, you can quickly assemble a rather comprehensive list of investment possibilities within any given sub-sector.

A look into the Food Products sub-sector reveals no less than 46 US-listed companies and their related securities. The information provided is limited to the name of the firm, the ticker symbol, last trade / trade date, volume, change($), and change(%). At this point, the biggest tendency for individual investors is to scan the list, find the name of a firm they know and start their search there. This is not the way to go; emotion has already entered the equation and in your mind you’re already playing favorites and biases have taken control of the process. At this point, you must consider your own objectives:

• When will you need this money?

• What do you anticipate eventually using the money for?

• How much money do you have to work with?

• What is your risk tolerance?

The answers to these questions will help you decide on what types of firms you’re looking for. Do you want large companies with low volatility that pay high dividends? If you’re approaching retirement, this might be the way to go. If you’re younger and are looking for capital appreciation, you might consider looking at some of the smaller companies that are more volatile, but have more room to grow. Are you risk averse? The fact that you’re looking at consumer staples to begin with might say something about your willingness to accept risk (wait, I picked that category!).

This is an important part of the process. We are now connecting the economic themes that we decided will be important with our own personal situation. The worst thing anyone can do is take his or her own themes, then just grab someone else’s prepackaged strategy without considering if it actually fits. It is the financial equivalent of buying a pair of trousers without bothering to look at the size, choosing rather to buy them because you thought they looked good on somebody else.

So in our hypothetical analysis, we decided that the economy is in recession and is likely to be there for some time, and have come to the conclusion that people will cut back on discretionary spending (which they have). We realize that inflation is a problem, and so leaving our capital in a bank account is not the greatest idea if we expect to maintain our purchasing power. Food products will certainly not be the only theme we invest in, but it is a good starting point.

Large or Small?

The next issue becomes the determination of what constitutes a large company and what constitutes a small one. Obviously, there are a number of characteristics that may be used to determine this, but one of the most generally accepted definitions is the firm’s market capitalization. Market capitalization is the share price multiplied by the number of outstanding shares. Another way of expressing market cap is that it represents the public opinion of the value of the company. The sizing of companies can generally be lumped into the following brackets:

• Large-Cap Companies $10 Billion – $200 Billion (or more)

• Mid-Cap Companies – $2 Billion – $10 Billion

• Small-Cap Companies – $200 Million – $2 Billion

• Micro-Cap Companies – Less than $200 Million

Using the Food Products sub-sector as our continuing example, of the 46 issues in that category, the breakdown is as follows:

As is evidenced by the chart above, there is a solid distribution of firms in this sector according to size as measured by market capitalization with most of the companies (33) falling in the small or mid cap range. This distribution is good news as it means that no matter what your investment goals and risk profile, you should be able to find a reasonable number of firms that are desirable for addition into a portfolio, or are firms that should be looked for when looking at ETFs and open/closed end funds.

Using this methodology it is fairly easy to drill down to potential specific investment possibilities from a variety of economic themes. What we need to accomplish next is creating a definition of value and the parameters by which we will measure it. Next time we’ll take a look at some of the popular valuation metrics and develop a few of our own as well, which we can add to our toolbox as we continue to chase the oftentimes elusive concept of value.

Individuals interested in learning more about the major macroeconomic themes should take a moment to listen to some of our informative podcasts. We’ve recently had guest experts like Laurence Kotlikoff; John Williams of shadowstats.com, and Bill Murphy of GATA appear to discuss their areas of expertise. For more information or to listen, please take a moment to visit www.my2centsonline.com/radioshow.php