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Today's Market WrapUp 06.23.2003 Mon Tue Wed Thu Fri Puplava Archive The Last Bullet?
The problem with credit is that it is like a narcotic. With repeated use, the body, or in this case the economy, gets immune to it and requires even larger doses to maintain a high. In the case of the U.S. it is now taking almost $5 dollars of debt to produce $1 dollar of GDP. The Fed’s answer to the problem is to inject even larger doses of credit into the system but the patient isn’t responding as readily as in the past. Money is still flowing into the financial system. The Fed is making sure of that. However, the rate of change in the expansion of credit is starting to slowdown and money velocity is declining. People are starting to develop a preference for cash and are holding on to it much longer. This is slowing down the rate of turnover of cash within the economy so the Fed is getting less bang for the buck, so to speak. As the graphs below indicate the money supply is still growing but at a slower rate. We have had two months out of this year where credit expanded which was in the month of January and in April. In between these periods the money supply has been flat or decelerating as in the graphs below.
The problem for the Fed is that each new dollar of credit isn’t turning over as rapidly so there is less of a multiplier effect. It could be that three years of devastating losses in the financial markets, wildly gyrating financial markets, and increasing unemployment is making consumers and investors more cautious. In Japan after more than a decade of deflation the government is now considering desperate measures to force engrained savings habits to disappear. The government in Japan is considering taxing all cash and savings in an effort to force people to spend money. A new plan being outlined by government calls for an annual tax of 3-5% on all savings and cash. The aim would be to get people to spend money or invest it in the stock market, bond market, or in real estate. According to Shukan Gendai, a leading Japanese newsweekly, the policy could get adopted next April when the government plans on introducing a new currency. If people fail to change their old ills they would become worthless. Japan has $12 trillion in savings. My only reason for mentioning this is that the same idea is being floated here. In recent speeches by Fed governors they have launched a series of trial balloons. There has been frequent mention of the idea of a “carry tax” if cash doesn’t start turning over more rapidly. The idea of too much debt to carry doesn’t even register. Like drug dealers, the thought of reducing business--in this case credit--has not dawned on anyone. The thought that people might think differently than those who inhabit ivory towers or work in marble buildings isn’t even an afterthought. When you lose a lot of money, when you have borrowed even more, or if you have lost a job, your behavior is much different. This is what has happened in Japan where real estate and stock market prices have lost more than 75 percent of their value. Investors in Japan have lost so much money over the last 12 years in real estate and in stocks that their propensity for savings has increased. They are trying to make up through savings for what they have lost in investments. This has caused them to hold on to their cash even more despite repeated attempts by government to get them to spend or invest it. The people of Japan have lost all confidence in government. Prime ministers come and go with average citizens looking out for themselves. This is becoming one of the Fed’s greatest fears--its own very worst nightmare. What does it do next when interest rate cuts fail to revitalize the economy or the financial markets? Unlike the Japanese saver/investor the average American is a borrower/consumer. The problem here in the U.S. is just the opposite in Japan. Americans hardly save at all. Not only do Americans not save, but we borrow from the rest of the world consuming about 80 percent of the rest of the world’s savings. The U.S. problem is too much debt. How do you get people or business to borrow more money when they are tapped out? Homeowners seem to be the only group within the U.S. that still has the capacity to borrow, mainly through tapping the equity from their inflated homes. But what happens when housing prices no longer rise, or if interest rates go up instead of down? That is when the real problems begin. Unless the Fed can create another asset bubble to tap to replace those that are in the process of deflating, we may be approaching the end of the road. The New Buzz Word: Deflation There are three asset bubbles in the U.S. today, which are the stock market (partially deflated), the bond market, and real estate. What concerns the Fed now is with so much credit in the system, what happens when all of these asset bubbles begin to deflate such as the stock market did between 2000-2002? You can’t keep asset bubbles inflated forever. That is why you hear the Fed speaking feverishly these days about “deflation.” The deflation they are referring to is asset deflation or the bursting of a bubble. Up until 2000 the Fed only had to contend with a stock market bubble. However, by massively inflating the supply of credit since 2000 they have created additional bubbles in the bond/mortgage market and in real estate. Mr. Greenspan’s repeated reference to deflation is of the credit variety type. It is what economist Irving Fisher refers to as debt-deflation, a dangerous condition that can become self-reinforcing once it begins. The reader can view the dynamic of Fisher’s debt deflation spiral below taken from today’s BCA Research's, Global Fixed Income Strategist. Bank Credit Analyst identifis a checklist for debt-deflation. A checklist of conditions to monitor is as follows: Debt
Deflation Checklist Of the ten conditions listed above, we have close to seven that are visible. Prices are falling for everything you want; while the price of everything you need is going up. This is stagflation. Money velocity is also dropping which is why Japan and the U.S. are floating the idea of a “carry tax” on cash if things don’t improve soon. Net worth is mixed. Stocks have fallen over the last three years but have risen this year. Real estate prices are still going up so most people feel that they are getting wealthier. Bankruptcies are increasing with mortgage foreclosures hitting a record high. With more people losing their jobs home mortgage foreclosures climbed to 1.2 percent of all mortgages during the first quarter of this year. And although there has been an improvement in the profit picture for most, companies that profit is coming at the expense of rising unemployment as companies try to slash costs in an effort to return to profitability. Distressed selling has subsided if only for a short while. Company capex spending has fallen precipitously since 2000 and has only partially recovered. One of the big “if’s” for the economy going forward in the second half of the year is capital spending by business. At the current moment there is a lot of hope but very few signs of improvement. Capex spending depends on profitability. With companies struggling to remain profitable business spending will remain a big “if.” Therefore the big $64 billion dollar question going forward is if the Fed will be able to resurrect the economy and financial markets with another rate cut, or if other more desperate measures will be needed. It appears that once again we are headed down the 1929 road. The only difference this time is that the U.S. is no longer the world’s largest creditor nation. The United States is no longer self sufficient in energy, manufacturing, and in capital. This means that the outcome, should we decide to proceed down this road again, will be entirely different; deflation in everything you want associated with credit and inflation in everything you need. In other words, “The Perfect Financial Storm.” Today's Market The markets suffered from a heavy bout of selling today. All major indexes fell with the NASDAQ losing 2.1 percent. The selling began with a profit warning from Tenet Healthcare. Fannie Mae added to selling pressure after a New York Times report that the mortgage maker may have suffered a loss last year that was obscured by accounting complexities. The recent warnings coming from high profile companies such as TI, Motorola, Unilever, EDS, Clorox, and Kodak suggests that Q2 earnings may not be as rosy as the recent run up in stock prices would suggest. The S&P 500 is up 16 percent this quarter, its best quarterly run since Q4 of 1998. The rapid rise in stock prices has raised investor and professional sentiment to near record levels. Bearish sentiment is almost nonexistent. The UBS Index of Investor Optimism leaped to 77 in June from 42 in May. Both the VIX and the VXN are at close to bottom suggesting complacency and lack of fear. The CBOE put/call ratio and mutual fund cash positions are flashing at extreme levels. We also have a no confirmation of Dow Theory with the Transports failing to confirm the Industrials. Even more worrisome is the McClellan Oscillator, which is also flashing a bearish divergence, so if we aren’t close to a turning point I would be surprised. What another rate cut from the Fed will do that 12 other rate cuts failed to achieve is anyone’s guess. Market gurus debate whether the Fed will cut 1/4 or ½ a point is meaningless. The Fed will announce its decision at the conclusion of this week’s meeting on Wednesday. What may be more important to the market may be what companies say about Q3 & Q4 rather than what they say about Q2. The expectations for Q2 have been reduced so low that the majority of companies will end up beating estimates. However, a lot is riding on a second half recovery. Earnings expectations are still too optimistic for the second half of the year no matter which way you measure them by either CRAP or GAAP. It is Q3 & Q4 that investors should now be focusing their attention on. Volume came in at 1.34 on the NYSE and 1.68 billion on the NASDAQ. Market breadth was decidedly negative by 24-8 on both exchanges. The VIX jumped 1.57 to close at 22.66 and the VXN fell .54 to 31.80. Copyright
© 2003 Jim Puplava Graphic Source: CNNMoney, Bloomberg, and BCA Research
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All
is not well. If it were, we wouldn’t have the Fed considering
desperate policy measures. Having cut interest rates 11 times in 2001
and then again in November of 2002, the Fed is once again
contemplating lowering rates when it meets tomorrow in Washington. The problem is after 12 rate cuts and near
zero interest rates, the patient isn’t healing and responding as
expected. After creating the largest credit boom in history the
economy is in danger of running out of steam. Capacity utilization is
still anemic with one out of four factories idle in the U.S. The
unemployment rate is still rising as companies lacking pricing power
move to slash payrolls to improve profitability and save cash.
