Gold Investment: Gold Is Well Positioned To Make A Run

When fear in the market is high, gold is in a good position to grow in value. While energy prices could fall if the global economy weakens, gold may ready for another bull run. See the following post from Expected Returns.

Over the past couple of months, gold has slowly retreated from all-time high prices, losing mainstream media coverage in the process. As veterans of the gold market know, gold makes its major moves when no one is paying attention. I don't know whether gold will explode higher today or 6 months from now, but I believe it is time to accumulate.

U.S. Dollar

Weakness in gold has, not surprisingly, coincided with dollar strength. The dollar is solidly above its 50-day moving average and has just broken through its 200-day moving average. If the dollar can hold above 78.5 on the dollar index, expect to see further strength.



Gold is firming up a bit here at the same time the dollar is showing strength. Gold is sitting in the lower range of a multi-week consolidation pattern, which suggests gold is a buy right now. Until we bust out of this range in either direction, I will use all pullbacks in gold to add to positions.



Gold Stocks

If I were looking to enter the gold space right now, I would turn to gold stocks. Gold stocks have taken a beating along with the general market. Most people are concerned about the effect of potential crash conditions in the stock market on gold stocks.

While these concerns are valid, I believe one should buy when value presents itself. Relative to the value of gold, gold stocks are very cheap. The rising gold:xau ratio demonstrates the relative undervaluation of gold stocks.

In valuing gold stocks, keep in mind that energy costs are likely to remain depressed relative to gold as the global economy weakens. Although gold and oil are lumped together in the general category of commodities, they are driven by different fundamental factors. While both commodities are subject to the rules of supply and demand, only gold shines in an atmosphere of fear. After all, people don't store barrels of crude oil when they mistrust governments or currencies.

Once fear reenters the system, gold stocks will explode.



We are currently at an interesting juncture where both the dollar and gold are showing strength. Perhaps gold and the dollar are close to decoupling for good, which I believe will be the signal that confirms we are now entering the most powerful phase of the gold bull market.

I understand that it is hard for investors right now to pull the trigger on gold stocks, especially given the obvious weakness in the general stock market. However, gold shares will likely decouple from the general market in the same way they did during the Great Depression, and more recently, in the first half of 2009. I will continue to buy on weakness, and hopefully, ride this bull market to its conclusion.

This post has been republished from Moses Kim's blog, Expected Returns.

Limits On Bank Risk Taking Could Be Good For Everyone

While the explanation by Obama on plans to introduce the "Volcker Rule" may have been poorly communicated, the limitations to bank risk taking could improve the financial system in the end. Eric Jackson from The Street discusses why the negatives of lower bank profits, lower liquidity would be greatly outweighed by the reduced risk for the US financial system. See the following article from The Street for more on this.

The proposed "Volcker Rule" isn't about being anti-business, it's about letting market actors do what they're best at.

Let banks bank, and let hedge funds trade. When either one does a poor job, let it go under and not pull the rest of the system with it. That's capitalism.

If bankers want to throw their own profits down a rat-hole with poor risk management, that's their right. Just don't do it with depositors' money

Last week, President Obama announced a series of planned reforms for the financial industry to prevent "too-big-to-fail" bank failures.

The centerpiece of these reforms was the so-called Volcker Rule, which restricts banks from getting into proprietary trading and owning, investing or sponsoring hedge funds or private-equity funds.

There has been much concern and hand-wringing about the long-term impact of these proposed changes since the announcement. The market -- and especially large bank stocks -- took a major hit following the announcement. The fears expressed were that Obama is anti-business and his misguided policies were going to kill off a nascent recovery just as it is starting to gain strength.

Hang on. First, we blame Obama that he, Treasury Secretary Tim Geithner, and Fed Chairman Ben Bernanke are too cozy with Wall Street, and no rules have been changed since the economic crisis began. Now, he's anti-business and his moves to reform the system to prevent systemwide risks are going too far.

Obama, generally regarded as a master communicator, did a horrendous job announcing the Volcker Rule. He came out, made an eight-minute speech, had no documentation to back it up and left after taking no questions.

Worse, his language was imprecise. The vacuum of information has directly led to the gnashing of teeth we've heard since then. Even now, a week later, we don't have further clarification. It's allowed pundits to surmise that the announcement was a knee-jerk reaction to last Tuesday's Massachusetts Senate loss. According to them, he's trying to be the left's populist version of Glenn Beck.

What was also confusing was that, after saying that banks couldn't do proprietary trading or even invest in a hedge fund or private equity fund, he said the following:

"If financial firms want to trade for profit, that's something they're free to do. Indeed, doing so responsibly is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities -- funds while running a bank backed by the American people."

I think we're all speculating -- he meant to say it was fine for banks to take some of their own money (as opposed to depositors' money) and trade it. What is not OK is taking in depositors' capital, that which is federally protected by the Federal Deposit Insurance Corp. and then levering it up 40-1 and making big bets.

As I argued in an article last month, why is it that hedge funds have to trade their own money or go out and justify to skeptical outside investors why their strategies and risk management are worthy of receiving capital -- and yet banks get to take in deposits from mom and pop and then trade them without having to justify anything?

I believe that it was big bankers' desire to keep their talent, maximize their profits and maximize their take-home pay that encouraged them to make bigger and riskier trading bets as last decade rolled on.

Those with the best risk management -- like Goldman Sachs(GS Quote) -- did well. Those with the poorest risk management - like Citigroup(C Quote) -- did the worst and have cost U.S. taxpayers the most.

The Volcker Rule is saying that banks can trade their own profits if they want but it should be their money -- not depositors' -- and stupid losses shouldn't bring down the whole enterprise and infect the system.

The arguments against the Volcker Rule are that: (1) it's not defined, (2) proprietary trading represents "only 10%" of banks' profits, and (3) doing this will reduce liquidity in the marketplace. In other words, the bankers are saying, "We're doing God's work, by buying positions from clients and putting them on our balance sheets -- and what will these poor souls do without us?"

First, it is not well-defined. This brief and vague announcement reminds me of Geithner's first public comments after being sworn in as Treasury secretary in February 2009. He said he was going to do something, but he didn't say what, and he had no staff to do anything anyway. The markets tanked for another month on fears he had no control of the situation. Finally, he released a more detailed policy paper and the criticisms of him slowed down.

On the point of this only being a small part of the banks' profits, well, then, they should have no problem giving this up. The truth is that these banks rely on these profits. Why would they want to give them up if they didn't have to? The question is: Does taking their right to trade depositors' money make the system stronger? I think the answer is clearly yes. (And, a note to Goldman Sachs: if you don't like these rules, don't classify yourself as a bank holding company, allowing you to borrow money from the Federal Reserve for free.)

As for reduced liquidity, just as when you divert a river, you can't stop the flow of a current. Capital will find a place to trade what it needs to. Hedge funds will likely step up to fill any hole left over from the banks.

What are the long-term impacts here of this rule, if it is enacted? Bank profitability will go down. Talent and assets will flow to hedge funds, away from big banks. Liquidity will find a home and be served. And the systemwide risk of big banks will be lowered, which most would agree is a good thing after 2008.

You can't make an omelet without breaking some eggs. And you can't reform Wall Street without actually putting some reforms in place. This rule will be a good thing for all market participants in the long run.

This post has been republished from The Street.

Does Bernanke Deserve Credit For Averting Another Great Depression

Glenn Hall from The Street points out that Bernanke did not have the advantage of hindsight like many of the individuals who are criticizing his actions. While mistakes were certainly made, the decisive action taken by the Fed was successful in averting a collapse into another Great Depression. See the following post from The Street.

I'm sick of hearing all the backseat drivers in the Senate with their 20/20 rearview vision taking potshots at Fed Chairman Ben Bernanke.

It's so easy for them to roll out the "woulda, coulda, shoulda" rhetoric now, when the financial crisis is under control and the economy is stabilizing.

I don't remember hearing so many brilliant ideas flowing from Congress when the crisis hit, when Bernanke and his team at the Fed sprang into action to prevent a repeat of the Great Depression. I do, however, remember the Fed taking decisive action quickly.

Are there things that could have been done differently? Of course. Bernanke himself acknowledges there are things he would have done another way if he had known then what he knows now. But he didn't. How could he? This was an unprecedented catastrophe stoked in no small measure by political and regulatory forces beyond the Fed's control.

That's right -- the very senators throwing stones today from their glass houses are complicit in creating the conditions that caused the financial collapse.

The support for loosening mortgage requirements came from both parties in both houses of Congress along with a decade's worth of White House occupants from Clinton to Bush.

Everyone wanted to make it easier for all Americans to own a home. Sounds good, but it turns out that not every American is ready for that responsibility.

How about this for a little back-seat driving -- why didn't lawmakers realize that loosening restrictions on lending requirements could snowball into such a disaster?

Why didn't the Senate question the risk of encouraging the likes of Bank of America (BAC Quote), Wells Fargo (WFC Quote), Citigroup (C Quote), JPMorgan Chase (JPM Quote) and other mortgage originators to provide more subprime loans.

Why didn't they question the loosening of restrictions on financial backing provided by the quasi-government (now fully government) agencies known as Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote).

All of that excess, which Congress fully embraced, led to an unprecedented situation that required the unprecedented actions Bernanke took.

It's easy now to reconsider whether AIG (AIG Quote) should have been allowed to fail or whether the Fed should have begun offering essentially free money to everyone from Goldman Sachs (GS Quote) to General Motors' GMAC unit.

But all of this brilliant hindsight ignores the fact that the only reason we have the luxury today to second guess the emergency actions Bernanke took back then is because Bernanke's approach worked. However flawed some of the individual reactions may have been, there's no questioning that we're better off today than we were a year ago.

So I say thank you, Ben Bernanke. You've earned the right to show what you can do for the economy when there isn't a crisis.

This post has been republished from The Street.

How Obama's Budget Freeze Could Backfire

Mark Thoma from Economist's View discusses his disappointment in Obama's new plan for a three-year spending freeze that is reported by the New York Times to be a main component in the State of the Union. Other economists think that this is a short-term band aid to America's deficit problems that could backfire with a negative impact on the economy and jobs. See the following post from Economist's View.

Here's the administration's latest bright idea:

Obama Seeks Freeze on Many Domestic Programs, by Jackie Calmes, NY Times: President Obama will call for a three-year freeze in spending on many domestic programs... The officials said the proposal would be a major component both of Mr. Obama’s State of the Union address...

Brad DeLong reacts (see here too):

Barack Herbert Hoover Obama?, by Brad DeLong: For some time I have been worried about fifty little Herbert Hoovers at the state level. Right now it looks like I have to worry about one big one...

What we are talking about is $25 billion of fiscal drag in 2011, $50 billion in 2012, and $75 billion in 2013. By 2013 things will hopefully be better enough that the Federal Reserve will be raising interest rates and will be able to offset the damage to employment and output. But in 2011 GDP will be lower by $35 billion--employment lower by 350,000 or so--and in 2012 GDP will be lower by $70 billion--employment lower by 700,000 or so--than it would have been had non-defense discretionary grown at its normal rate. (And if you think, as I do, that the federal government really ought to be filling state budget deficit gaps over the next two years to the tune of $200 billion per year, the employment numbers are more like 3.3 and 3.7 million in 2011 and 2012, respectively.) ...

As one deficit-hawk journalist of my acquaintance says this evening, this is a perfect example of the fundamental unseriousness of Barack Obama and his administration: rather than make proposals that will actually tackle the long-term deficit in a serious way--either through future tax increases triggered by excessive deficits or through future entitlement spending caps triggered by excessive deficits--he comes up with a proposal that does short-term harm to the economy as an alternative to tackling the deficit in any serious and significant way.

As another points out, it is hard to imagine a less competent legislative operation: it would be one thing to offer a short-term discretionary spending freeze (or long-run entitlement caps) in return for fifteen Republican senators signing on to revenue enhancement triggers. It's quite another to negotiate against yourself by attacking employment in the short term. ...

I can't disagree at all. This is pretty disappointing.

The long-term budget problem is due to primarily one thing, rising health care costs. Everything else is dwarfed by that problem. If we solve the health care cost problem, the rest is easy. If we don't solve it the rest won't matter.

This was an opportunity for Obama to explain the importance of health care reform and how it relates to the long-term debt problem. Why not emphasize this?:

Sam Stein: Orszag Calls Senate Health Care Bill Biggest Cost-Container Ever Considered: The health care bill before the Senate would cut costs and reform health-care delivery more than any piece of legislation in American history, White House budget director Peter Orszag declared on Wednesday. "The bottom line is the bill that is currently on the Senate floor contains more cost containment and delivery system reforms in its current form than any bill that has ever been considered on the Senate floor period," the Office of Management and Budget director told reporters...

Instead we get cheap political tricks that are likely to backfire. How will this look, for example, if there's a double dip recession, or if unemployment follows the dismal path that the administration itself has forecast?

This seems to be a case of the former Clinton people in the administration (or wannabees) trying to relive their glory days instead of realizing that those days are gone, the world is different now and it calls for different solutions.

I wasn't in favor of having so many Clinton administration people in this administration, and nothing so far has caused me to change that assessment. They're nothing but trouble.

Update: Here's an updated interpretation of the policy.

This post has been republished from Mark Thoma's blog, Economist's View.

Housing Market Data Indicates Price Trend Improvement

John Lounsbury from The Street analyzes the home price data from Case-Shiller, NAR, and FHA to conclude that housing recovery is still far off. Housing prices and sales of existing homes are showing an overall trend of improvement, while sales of new homes is heading downward. See the following post from The Street.

The widely followed Case-Shiller Home Price Index out this morning showed a decline for November compared to October, but just barely.

The Composite-10 Index, covering 10 of the largest metropolitan housing markets, was $158,490 in November, down from $158,820 in October. The broader Composite-20 showed similar results, with a decline from October of 0.2%, the same as the Composite-10.

Compared to a year ago, prices for the two indexes were down 4.5% (Comp-10) and 5.3% (Comp-20). The year-over-year rates of price decline continue to improve, as shown in the graph provided by S&P Case-Shiller below.



Because the Case-Shiller (C-S) index reports a three-month moving average, the effect of the end of the 2009 first-time home buyers tax credit is muted compared to the data from the NAR (National Association of Realtors).

The November declines in the NAR existing home prices were -1.2% from October and -5.7% year over year. When the NAR data is viewed through the prism of a 3-month moving average, the numbers are even more different from the C-S results. The 3-month moving average changes are -1.4% month to month and -7.2% year over year for the NAR data.

I can only attribute this to the geographic scope of the two surveys: C-S monthly surveys cover only 10- and 20-city markets, whereas NAR is a national survey. The implication is that the improvement trends (declining more slowly) are lagging outside of the 20 major markets.

Another monthly housing price index was also published today by the Federal Housing Finance Agency. This report, which covers homes sold with FHA conforming mortgages, found that prices rose 0.7% for November from October. Year over year, November was up 0.5%. This indicates that homes with FHA mortgages are behaving better than the complete market. The FHA conforming market is restricted to mortgages less than about $420,000, the limit for most areas of the country.

The fourth home price measurement is the New Home Median Price compiled by the U.S. Census Bureau. That report for December will be issued Wednesday.

The following graph shows the behavior of all four indexes since the housing market prices peaked in early 2007.



The messages from this data are mixed. Key observations:

• The quadratic trend lines for C-S and FHFA are cupped (curving toward the up side) indicating price trend improvement.

• The NAR quadratic trend line is domed (curving downward) indicating price trend degradation.

• The new home price quadratic trend line is nearly linear indicating little trend change. The seasonal cycling effect is obvious in the NAR data.

• All four curves are above their quadratic trend lines, a positive situation.

• The three-month moving averages are all very close to the 12-month moving averages. This is a neutral situation.

Sales volumes are much more problematic. Last week's bombshell was the dramatic drop in existing home sales reported for December by the NAR. The established trend in sales volume had appeared to be headed up, as shown in the following graph. It appears that the December sales volumes for existing homes may have returned to an extension of the gradual up slope that existed before the market was distorted by the first time home owners' tax credit.



Meanwhile, new home sales volume has declined throughout the second half of the year, even in the face of the tax credit. It looks very much as if new home sales may again reach the low levels of early 2009.

The December data due from the Census Bureau Wednesday will go a long way toward determining how likely the lows in numbers of new homes may not yet have been reached.

This is not good news for the home builders, such as Toll Brothers(TOL Quote), D.R. Horton(DHI Quote), Hovnavian(HOV Quote), Pulte Homes(PHM Quote), KB Home(KBH Quote)and Lennar(LEN Quote).

Has housing stabilized? Maybe in some regards, but it remains to be seen how an additional two to three million foreclosure homes becoming available in 2010 will impact the market. It is unlikely that the new home segment of the market will stabilize until the wave of foreclosures comes to an end, which may well after 2010.

What we may see is the existing home market continuing to slow its decline and going through a broad bottom over the next one to two years, but the new home market may well not bottom for some time.

For new homes, which have a higher cost per square foot, it's all a matter of supply and demand. New homes will continue to face an over supply of existing homes and a weak demand based on price point.

This post has been republished from The Street.

Housing Sales Slide Shows Flaws In Tax Credits

The biggest December decrease in housing sales on record was a result of the end of the original homebuyer tax-credit which encouraged first time homebuyers to rush to beat the Nov 30th deadline. Moses Kim from discusses why artificially propping up the housing market doesn't work in the long term. See the following post from Expected Returns.

No surprise here. This is just a glimpse of what will happen when the government removes the homebuyer tax-credit permanently. Our government specializes in temporary solutions to long-term structural problems- solutions that make problems worse in the long run. This will end badly, especially since the Federal Reserve has essentially become the sole buyer of toxic waste from Fannie Mae and Freddie Mac. Housing is getting propped up from all directions, and yet there is hardly any effect. This is concerning. From Bloomberg, Existing U.S. Home Sales Decreased More than Forecast:

Sales of existing U.S. homes plunged in December more than anticipated, the month after a government tax credit was originally due to expire.

Purchases decreased 17 percent, the biggest decline since records began in 1968, to a 5.45 million annual rate from 6.54 million pace the prior month, the National Association of Realtors said today in Washington. The median sales price increased for the first time in two years, reflecting fewer first-time buyers, the group said.

First-time buyers rushed to complete deals before the $8,000 government incentive was expected to end on Nov. 30. The subsequent extension and expansion of the credit, together with the one- to two-month delay between contract signings and closings, signals demand will pick up again in the first half of this year.

You don't necessarily want homebuyers, especially first-time homebuyers, rushing to close deals simply to receive a tax credit. The steep decline in home sales immediately after the expected expiration of the tax-credit shows you how artificial the demand for housing in previous months was. This is still a weak housing market- after all, if the housing market were really stabilizing, the government would not have to step in with a tax credit, let alone extend it.

When the dust settles, there will be an army of homeowners who had no business owning a home in the first place. Sound familiar?

Tax Credit Extension- Prolonging the Agony

President Barack Obama and Congress extended the first-time buyer credit to cover deals signed by April 30 and closed by June 30, and expanded it to include current homeowners. Even so, some economists believe the original measure pulled sales forward, restraining demand for a few months.

After rebounding early this year, sales will probably fall off again after June, Yun said in the press conference. The degree of the decline will depend on the state of the job market, he said.

Yun said he was “generally pleased” with the December outcome since he was fearing an even larger drop following the expiration of the tax credit. “There is an increase in home- buyer confidence,” he said, adding “there is some sustainable momentum” in sales. Even with the decline, sales were still up 15 percent from the same month last year, signaling the general improvement, he said.

We might as well just make the tax credit permanent and effectively raise the price of all homes by $8,000. Let's throw more taxpayer money at homebuyers who would have bought homes even without tax credits. After all, we are becoming experts at wasting taxpayer money, why stop now?

There is no recovery in unemployment, which means there will be no recovery in housing. In the context of previous bounces off lows in economic activity, we are experiencing a very weak recovery. This suggests the second dip in our economy will be pretty nasty. Very few sectors of our economy will survive unscathed, and this includes housing.

This post has been republished from Moses Kim's blog, Expected Returns.

Obama Needs To Refocus On Job Creation

Glenn Hall from The Street points out that the number one priority for Obama should not be healthcare or financial reform but rather generating jobs. Unless Obama can start creating jobs, his approval rating will continue to fall. See the following post from The Street.

As President Obama prepares to deliver his first state of the union speech this week, there is only one thing he needs to do -- persuade Americans that he can create new jobs.

Little else matters. Obama can yammer on all he wants about punishing bankers and vilifying fat cat lobbyists who threaten his health care agenda, but what America really needs is an economic recovery that puts the 15 million unemployed Americans back to work and gives the additional millions of Americans who've dropped out of the workforce a reason to try again.

So far, the employment numbers keep going down, and so do Obama's approval ratings.

The U.S. lost 85,000 more jobs in December and just today Wal-Mart (WMT Quote) said it will shed about 11,200 jobs at its Sam's Club warehouse, primarily by outsourcing in-store demonstrations to a marketing company.

Meanwhile, 53% of respondents disapprove and 41% strongly disapprove of Obama's job performance in the Rasmussen Reports daily Presidential Tracking Poll for today.

Now, just like a year ago, the public's priorities for Obama and Congress are to shore up the economy, rev up the job creation engine and defend us from terrorists, according to a recent Pew poll.

Nothing else comes close, not even health care or financial regulation.

The bottom line is that beating up on Bank of America (BAC Quote), Goldman Sachs (GS Quote) or Citigroup (C Quote) won't score as many points with the public as hunkering down on some good old-fashioned economic packages.

Job creation is the surest indicator of whether economic improvements are underway, and so far we're not seeing the results.

This post has been republished from The Street.

China Cuts Purchases Of US Debt

Foreign countries are buying less US debt especially China who significantly cut their purchases of US treasury securities. With the US borrowing more money than ever, this could lead to a US funding crisis. See the following from Expected Returns for more on this.

As America heads down the road to insolvency, its creditors will attempt a stealth exit from the Treasury market. From the looks of the latest Treasury data, it looks like China is going to lead the move away from U.S. debt. From the New York Times, Debt Burden Now Rests More on U.S. Shoulders:

THE United States government borrowed more money than ever before in 2009, but its largest lender — China — sharply reduced the amount it was willing to lend.

The United States Treasury estimated this week that during the first 11 months of last year China raised its holdings of Treasury securities by just $62 billion. That was less than 5 percent of the money the Treasury had to raise.

That raised its holdings to $790 billion, leaving it the largest foreign holder of Treasury securities — Japan is second at $757 billion and Britain a distant third at $278 billion. But China’s holdings at the end of November were lower than they were at the end of July.

As America's current account deficit declines, especially with China, there will be a scarcity of dollars to support the Treasury market. This is one of the many reasons why the Fed has taken on the onus of directly buying debt. The graph below shows the troubling trend of our #1 banker giving us the cold shoulder.




The Mythical "Household Sector"

During the full year of 2009, the volume of outstanding Treasury securities owned by the public — as opposed to United States government agencies like the Federal Reserve or the Social Security Administration — rose by $1.4 trillion, a 23 percent gain, to $7.8 trillion. In dollar terms, that was the largest annual increase ever, but as a percentage increase it slightly trailed 2008.

But total foreign purchases in the 11 months financed only 39 percent of the borrowing, leaving American investors to purchase the remainder. As recently as 2007, foreigners were buying more Treasuries than the government was issuing, enabling Americans to reduce their Treasury holdings even as the government borrowed hundreds of billions of dollars.

The public sector is very broad, and includes a household sector that isn't adequately defined. Essentially, the household sector, which accounted for about half of the growth in public ownership of debt, is comprised of all Treasury purchases outside of the standard categories (government, foreign, pension funds, money market funds etc.). In all likelihood, the household sector is a front for direct government purchases.

Foreign governments around the world are dealing with their own domestic economic issues, which obviously weakens their ability to purchase our debt. This will exacerbate the funding crisis in America as our issuance of debt increases.

The debt situation is a lot more delicate than most people realize. I don't know how much longer the Fed can get away with this con game, but I suspect it will come to an end soon via a sharp increase in yields.

This post has been republished from Moses Kim's blog, Expected Returns.

What To Do About Fannie And Freddie

The potential half a trillion cost to keep Fannie and Freddie alive has led to questions about whether the government-sponsored-enterprises should be replaced. The government's controversial agreement to absorb unlimited losses for the next three years from the mortgage giants could add to the unsustainable budget deficit. See the following post from The Mess That Greenspan Made for more on this.

Wow. Elected officials are really getting carried away in their response to the loss of Ted Kennedy's seat in Massachusetts. There's reform in the air all over the nation's capital, Bloomberg now reporting that Rep. Barney Frank (D-MA) is recommending that wards of the state Fannie Mae and Freddie Mac should be abolished

“The committee will be recommending abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance,” Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, said at a hearing in Washington today. “That’s the approach, rather than a piecemeal one.”

The companies, the largest sources of money for U.S. home loans, were seized by regulators almost 17 months ago because of their risk of failing and have since survived on $110.6 billion in taxpayer-funded aid.

Wasn't it Barney Frank who said a couple years back that the GSEs needed to do more to help the housing market recover (on a temporary basis).

Earlier today, a story in the Wall Street Journal indicated that the Government Accounting Office wants to combine Fannie and Freddie's books with the government's books, a move that would cause U.S. deficits and the national debt to rise - maybe a lot.

The U.S. government's move to deepen its ties to mortgage-finance giants Fannie Mae and Freddie Mac by agreeing to absorb unlimited losses for the next three years is igniting a debate over whether it should bring the business operations of the companies onto its books.

A decision on how the government treats Fannie and Freddie could have broader political implications. So far, the White House has resisted calls by Republicans to bring Fannie's and Freddie's obligations onto the government's books, a move that could boost the federal deficit by tens of billions of dollars.

Recent estimates have put overall losses at Fannie and Freddie at almost a half a trillion dollars. Can the U.S. government absorb all those losses?

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Long-Term Bull Market For Gold Investment

Moses Kim explains why gold equals money and the value of gold will inevitably increase when the excess money printing policies finally catches up with us. A government default, high inflation, or a general panic could send gold values soaring. See the following post from Expected Returns.

The volatility we are currently witnessing in the gold market, especially in gold shares, is something we have not seen in some time. This reminds me a lot of 2008 when gold shares would have 10-20% days both on the upside and the downside. Newcomers to the gold market are no doubt throwing in the towel.

In five years, current prices will look like a gift. With that being said, I want the new money in gold out. I want the media to start bashing gold. I want Nouriel Roubini to pat himself on the back on National TV and convince even more people to sell. Then I'll know we're close to reversing.

Gold will eventually start basing, perhaps at the $1,050-$1,070 dollar level, and start the next phase of this bull market. When it does, I want to have a large position in place. This means buying on weakness, however hard that may be at the time.

I assume most of my readers are "gold bugs". But even so, it pays to have occasional reminders of why we are invested in gold. With that in mind, I present you with one of the best gold quotes of all time from the Maestro himself, Alan Greenspan:

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. ... This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

Make no mistake about, the attacks against gold are colored by a bias against what gold offers- namely protection against governments and their #1 ally, the printing press. Governments always make promises that they cannot possibly keep. Two mammoth promises, Social Security and Medicare, are about to be broken. The political backlash will be quite severe. Gold will rise in response.

Long-Term Bull Market

Gold is in a very healthy upward trend, even in the following arithmetic chart. As long as we hold above $800 dollars, the long-term bull market remains intact. This means you should be buying every dip.



Loss of Confidence= Gold Explosion

Although many Americans are starting to wake up to the corruption of our government officials, most Americans are still asleep. Anyone who criticizes the government is labeled a right-wing extremist or conspiracy theorist. The uneducated masses nod in zombie-like agreement while getting robbed in broad daylight. As an American, this is very sad to see.

Eventually, there will be a general panic that will send gold prices flying. I am just unsure about what the catalyst will be. Perhaps it will be a mini run on banks once mark-to-fantasy accounting is removed. People who have been conditioned into believing that paper is money will then find out what "gold bugs" have known all along: gold is money.

Bring out the Helicopters Ben

What people need to understand is that our economy is exhibiting incredible weakness, especially when you account for the stimulus the Fed has pumped into the system. Jobless claims are rising again, housing starts are down, and consumer confidence is falling. Once residential real estate starts falling again, things will get messy. Refer to the chart below to get a glimpse of the massive resets that lie ahead. Folks, get ready for the double dip.



Serious cracks will emerge in our economy soon. "Unexpected" economic weakness will be met by "extraordinary" measures by the Fed. Helicopter Ben will use high-brow economic jargon to mask what he is really doing, which is printing money. From his perspective, there is no other way out of this debt crisis. Default is not an option.



Gold Outlook

I would like to see gold reverse in the next week or two- otherwise I think we're in for a more prolonged decline, which I believe will be measured in months. Nonetheless every sell-off is a buying opportunity for those with eyes to see. Prepare while every one is sleeping.

This post has been republished from Moses Kim's blog, Expected Returns.

Obama Teams With Volcker For New Financial Regulation

Obama introduced a new proposal for financial reform that would aim to limit risks and size of the nation's banks. The plan is championed by former Fed chairman Paul Volcker aims to prohibit certain risky trading behavior by commercial banks. See the following from Economist's View.

It looks like the political winds have shifted away from Tim Geithner/Larry Summers and toward Paul Volcker/Elizabeth Warren:

Obama to Propose Limits on Risks Taken by Banks, by Jackie Calmes and Louis Uchitelle, NYTimes: President Obama on Thursday will publicly propose giving bank regulators the power to limit the size of the nation’s largest banks and the scope of their risk-taking activities...

The president, for the first time, will throw his weight behind an approach long championed by Paul A. Volcker... The proposal will put limits on bank size and prohibit commercial banks from trading for their own accounts — known as proprietary trading. ...

Mr. Volcker flew to Washington for the announcement on Thursday. His chief goal has been to prohibit proprietary trading of financial securities, including mortgage-backed securities, by commercial banks using deposits in their commercial banking sectors. ...[T]he concern is a new type of activity in which financial giants like Citigroup, Bank of America and JPMorgan Chase ... operate on two fronts. On the one hand, they are commercial banks, taking deposits, making standard loans and managing the nation’s payment system. On the other hand, they trade securities for their own accounts, a hugely profitable endeavor. This proprietary trading, mainly in risky mortgage-backed securities, precipitated the credit crisis in 2008 and the federal bailout.

Mr. Volcker ... has gradually lined up big-name support for restrictions on such trading. ... Under the new approach, commercial banks would no longer be allowed to engage in proprietary trading, using customers’ deposits and borrowed money to carry out these trades. ...

I want more details, these proposals don't exhaust the needed changes, and who knows what Congress will actually do -- I don't think we'll get anywhere near the amount of change we need when all is mostly said and little actually gets done -- but this is a move in the right direction. Too bad it didn't happen months ago. [dual posted]

This post has been republished from Mark Thoma's blog, Economist's View.

A Mountain Of Commercial Real Estate Debt Is Coming Due

$566 billion in commercial real-estate debt comes due in 2010 and 2011 and already 20% of construction loans are past due. A flood of commercial property defaults could significantly devalue commercial property and put banks in serious trouble. See the following discusses from Moses Kim from Expected Returns.

A lot has been made about the plight of commercial real estate. With prices off over 30% from peak levels, there's not much to be optimistic about: commercial property sales are plummeting, and vacancies are rising along with unemployment. This does not bode well for future bank earnings. From the WSJ, Unfinished Real Estate Projects Weigh on Banks:

For its neighbors in the city's wealthiest area, the Streets of Buckhead is an unfinished eyesore, not the glitzy shopping district promised at the height of the real-estate boom.

For Bank of America Corp., the project's biggest lender, it is a microcosm of commercial-real-estate problems faced by banks nationwide as builders default on loans and valuations tumble.

The project's developer is in talks to raise $200 million to complete the stalled project. As part of the deal, Bank of America is negotiating to potentially swallow a loss on the $160 million loan it made to the developer before construction began, people familiar with the matter said.

The bank is not alone. Lenders across the country are being forced to make unpalatable choices, including putting up more cash, extending loans or agreeing to lower their rights to collect on the debts, as they try to keep projects afloat.

Extend and pretend at its finest. Although certain types of commercial real estate have been firming up, properties under construction are very vulnerable to sustained weakness in the economy. There will come a point when banks will have to face reality and take losses, but of course, not before taking one last dip into the bonus cookie jar.

Non-Performing Loans Rising

Today, Streets of Buckhead is one of many high-profile developments in the country halted by the economic downturn and financing drought. Real-estate developments are among the biggest headaches for banks because they are huge capital drains and, in most instances, demand for space and rents in their markets are falling below projections. As of the fourth quarter, about 20% of $440 billion of construction loans outstanding were more than 30 days past due, according to Foresight Analytics, compared to 11.4 % a year ago.

Delinquencies are still rising for commercial real estate properties. Note that tremendous weakness in commercial real estate is occurring against a backdrop of massive governmental support (TARP). This does not augur a quick recovery in commercial real estate valuations.

Praying for a Recovery

Banks will have their hands full in the coming months. About $566 billion in commercial real-estate debt, the majority of which was provided by banks, comes due in 2010 and 2011, according to Oakland, Calif., research firm Foresight Analytics LLC. The struggling commercial real-estate loan market is increasingly cited by bank regulators as a growing concern. The Federal Reserve's Jan. 13 "beige book" survey of regional economies said commercial property markets remained weak.

The report highlighted loan restructurings, noting, "There is still some concern over how commercial-real-estate loans will be worked out as they come due, given the decline in collateral value."

If the commercial real estate market remains at depressed levels, there will be a cascade of defaults, since loans are collateralized by the value of the property. Rising defaults will further pressure commercial real estate valuations.

Either commercial real estate prices start rising soon, which is heavily dependent on the employment picture, or we are primed for the next leg down in commercial real estate. It will be interesting to see how long banks can hold out before capitulating.

This post has been republished from Moses Kim's blog, Expected Returns.

Putting The Increase In Building Permits Into Perspective

Although housing starts surged in November and new building permits increased in December, if you take a 30,000 foot view it is relatively insignificant. Tim Iacono points out that the current annual rate of permits issued is far below the previous lows in 1975 when adjusted for population. See the following from The Mess That Greenspan Made.

The Census Bureau reported(.pdf) that housing starts declined but permits for new construction surged during the month of December in what continues to be a difficult period for the home building industry as new home construction remains near record lows.



Housing starts fell 4.0 percent after jumping 10.7 percent the month prior while the number of permits issued, a leading indicator for home building activity, jumped 10.9 percent in December after rising 6.9 percent in November.

Anyone interpreting the surge in permits as a sign of recovery should be reminded that this is very much a case of "one is greater than zero" since, for housing starts and permits, the entire year of 2009 was spent in record low territory for a data series that began in 1959.

For example, the current annual rate of 653,000 for permits issued, down 71 percent from the 2005 high, is still below the pre-2008 record low of 709,000 set back in March of 1975. When adjusted for the increase in population over the last 34 years (from about 215 million to 310 million), the current level of permits issued is almost 50 percent below the 1975 low.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

What Could Cause A US Default On Its Debt

Once thought an impossibility, the default of the United States on its debt is now being talked about as a potential outcome. Moses Kim points to corruption, a collapse of confidence, and overvaluation of the dollar as problems that could lead to a US default. See the following from Expected Returns for more on this.

For years, Cassandras have been warning of an economic collapse in America driven by a default on our national debt. Yet amazingly, in the face of accruing liabilities, foreigners have continued to fund the lavish lifestyles of Americans.

The specter of a wave of sovereign debt defaults is becoming more of a possibility daily. Historically, waves of sovereign debt defaults follow periods of relative calm in credit markets. In short, sovereign defaults are contagious.

While the first wave of defaults is likely to be in the Eurozone, where Maastricht Treaty- mandated debt to GDP ratios of 60% are being dismantled, America is not well on its way to defaulting itself.
Is a sovereign debt default possible in America?

First off, there are a couple of different forms of default. There is the outright default model accompanied by a repudiation of debt, which would be the Revolutionary Russian and Revolutionary Chinese model of default. Then there's the de facto default, which implies inflation.

Sovereign debt defaults are historically characteristic of emerging economies. Since emerging economies tend to be procyclical, economic downturns apply significant pressure to debt servicing ability. Mature economies like the United States are thought to be immune from default.

In the following chart, notice the subtle shift that signifies over-indebtedness is increasingly becoming an advanced economy phenomenon.



It is certainly true that highly developed economies have a higher tolerance for debt than emerging economies. Heck, even Japan is still chugging along with a debt to GDP ratio approaching 200% (although this is partly offset by their massive foreign exchange reserves). But even accounting for their foreign exchange reserves, Japan is long overdue for some serious credit dislocations.
The Argentinian Model of Debt Default

If you are looking for a wealthy nation to fall victim to repeated debt defaults, look no further than Argentina. Based purely on resources, Argentina should be one of the richest nations in the world. However, Argentina has been susceptible to sovereign debt defaults throughout its history.

What was it about Argentina that made repeated sovereign debt defaults possible, and are these characteristics prevalent in the United States today?
Kleptocracy

The level of corruption at the highest levels of government is reaching comical levels. In the face of rising public opposition, our government has continued to loot Americans and effectively hand the money to banks that gambled and lost.

What tends to happen in Kleptocratic regimes is that huge sovereign debt loads profit the few at the expense of the majority. Let me give you one example.

Senator Christopher Dodd is a shining example of the average corrupt politician that now inhabits Washington D.C. As Chairman of the Senate Finance Committee, Senator Dodd failed to regulate Fannie Mae and Freddie Mac, turning a blind eye to clear fraudulent behavior. I guess it's a coincidence that he received the most campaign contributions from Freddie and Fannie Mae out of any politician.

The corruption doesn't end there. Senator Dodd also received preferential mortgage rates for his political support of the now non-existent Countrywide Financial.

Our political system is one big joke. Americans caught up in the ridiculous left-right paradigm are seriously missing out on the bigger picture.
Collapse of Confidence

Confidence is a funny thing. The move from long-term to short-term sovereign debt leaves a country more vulnerable to a sudden collapse in confidence by global creditors.

In the United States, the move to shorter-dated securities is well underway. Don't underestimate the ability of capital outflows to turn from a trickle to a flood in short order. The move to short-dated securities is the first step in the process. If our government officials keep on bungling the handling of this crisis, expect capital flows to flood out of the U.S.
Overvalued Currency and Exchange Rates

Overvalued currencies pose a problem for over-indebted countries due to the relationship of the relative strength of a currency and demand for bonds. If a country's currency is declining in value, the value of the country's bonds will fall in unison.

In the period preceding its debt default, the Argentinian peso was pegged to the dollar, which kept the peso artificially overvalued. Eventually, the overvalued peso applied pressure to Argentinian exports and helped push Argentina into a recession.

I believe the dollar is similarly overvalued, which stems from its position as the world's reserve currency. There is little doubt in my mind that the dollar will lose its reserve currency status, which will likely be met by a revaluation globally.

If the dollar weakens against a basket of currencies, which is effectively inflation, demand for our debt will decline. In the post-gold standard system, there is a strong correlation between rising inflation rates and sovereign debt defaults.
Conclusion

History proves that governments with the biggest armies get away with defaulting on debt. However, the consequences of such a default are significant, especially in the short term. Consider for a moment that 40% of new issues of our debt are being funded directly by our government. In the event of a debt default, that figure would be much closer to 100%, which would result in a massive inflationary spiral.

As a result, rates on all types of loans, most importantly mortgage rates, would rise significantly and severely depress economic activity. Credit booms are followed by credit busts, which directly affects interest rates. This is part of the reason why credit contractions are just different beasts.

The U.S. will likely default on its debt through inflation, and perhaps a restructuring of debt. When this occurs, the timeline for recovery will likely be moved back another 5-10 years.

This post has been republished from Moses Kim's blog, Expected Returns.

China Experiencing Vegas-Like Property Inflation

With China's housing prices increasing a staggering 7.8 percent in December, China has taken strong measures to cool the market and prevent a Dubai-like property crash. They have reimposed a sales tax on homes sold within five years and are requiring that second homes are purchased with a 40 percent down-payment. See the following from The Mess That Greenspan Made.

News reports about dangerous asset bubbles in China are now reaching a crescendo as the government continues to take steps to rein them in. Bloomberg has a number of reports today about soaring home prices, soaring stock prices, and one famous investor who now sees a bubble. First up, a story about the bubblicious property market

China property sales jumped 75.5 percent to 4.4 trillion yuan ($644 billion) last year, led by the eastern cities of Zhejiang and Shanghai, as record new loans boosted buying.

The sales data follows last week’s announcement that December property prices rose 7.8 percent, the fastest pace in 18 months, adding urgency to government efforts to rein in speculation. China this month reimposed a sales tax on homes sold within five years of their purchase while the country’s cabinet on Jan. 10 urged strict application of a 40 percent down-payment requirement for second homes. The measures are likely to weigh on first-quarter sales, economist Lu Ting said.

While the steps being taken to curb the speculative fever are shocking by U.S. housing bubble standards, so too are the statistics above which are said to - amazingly - understate the home price gains last month.

After the various housing bubbles the world has seen in recent years, the 7.8 percent gain (that, according to one economist may really be as high as 20-30 percent) is simply astounding. The biggest monthly gain for the S&P Case-Shiller 20-City Home Price Index over the last ten years was only two percent.

Even in Las Vegas - what used to be housing bubble central, but is now better known as the national leader in foreclosures - the biggest monthly gain was just 6.0 percent in 2004.

They certainly have their work cut out for them in Shanghai trying to reel the property bubble in and they're no doubt hoping that stocks will obey as well. This report provides the latest details on equity markets where, after a huge run-up last year, some calm has been restored.

China’s stocks advanced for a third day on the prospect the nation’s economic recovery and the Shanghai Expo will boost earnings for airlines and hotels.

China Eastern Airlines Corp., the nation’s third-largest carrier by fleet size, added 5.1 percent after saying it may have swung to a profit last year. Shanghai Jinjiang International Hotels Development Co., the biggest hotel operator, advanced 7.5 percent after President Hu Jintao visited the site of the exhibition that starts in May.
...
The Shanghai Composite Index rose 12.95, or 0.4 percent, to close at 3,237.1. The gauge has lost 1.2 percent this year on concern the government will tighten lending standards to avert asset bubbles. The index rallied 80 percent in 2009. The CSI 300 Index added 0.5 percent to 3,500.68.

Foreign exchange reserves were also on the rise last year, climbing to $2.4 trillion as noted at the end of the report. That's not helping to make the post-2008 crash financial world less prone to spawning even more bubbles.

Jim Rogers seems to be getting a little concerned about all of this. After lambasting Jim Chanos in recent days about his calls for a China collapse of epic proportions (Dubai times 1,000 was the characterization), Rogers seems a bit less sure of himself in this story.

Shanghai and Hong Kong property prices may fall after being driven higher by speculative demand, said investor Jim Rogers, author of “A Bull in China.”

Efforts to restrain lending underscore the government’s attempt to take “some of the heat out of the economy,” he said in an interview in Bloomberg’s Singapore bureau today. The rest of the Chinese economy is “hardly in a bubble,” he said.
...
“Certainly, Shanghai real estate or Hong Kong real estate should decline,” said Rogers, 67. “My goodness, if anything’s in a bubble in the world, that and U.S. government bonds are certainly very overpriced.”
...
“China now realizes that they’ve created too much money, that prices are going up too much and they’re trying to slow things down,” Rogers said. “These things are designed to take some of the heat out of the economy. Let’s hope it works.”

Has Rogers ever commented on all the copper being stored on Chinese pigfarms?

That would seem to be an important consideration regarding his current view that other parts of the Chinese economy and financial markets are not similarly bubbly (see here and here for more on that subject).

While Rogers has a tremendous track record over the years and has been quite good on nearly all of his long-term market calls, he has been famously wrong on a number of important occasions. About five or six years ago he repeatedly poo-pooed the idea of gold as an investment because he thought the central banks had too much of the stuff and would be willing sellers - not buyers - in the years ahead.

It turns out that central banks have been net buyers for a year now with no end in sight.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

2010 Economy Faces Significant Headwinds

One of the headwinds facing the economy in 2010 is the slow jobs market that is likely to take a long road to recovery. The sliver of hope is in the closing gap between job separations and new hires, although long-term unemployment has reached the highest level since 1948. See the following from The Capital Spectator.

The U.S. labor market is far from healthy, and the prospects are low for changing that diagnosis any time soon. But there’s a small ray of hope for thinking that the net loss of jobs is over and maybe, just maybe, some degree of expansion is near. Last week’s update on new hires is one of the positive smoking guns for expecting a better job market in the weeks and months ahead, if only marginally so.

It’s hard to overestimate how much influence the labor market will color the details of the economy in 2010. Suffice to say we’re at the point that the trend in jobs will have an outsized effect on what unfolds in the year ahead, for good or ill. A surprisingly strong recovery? A double-dip recession? Or something in between? We think the third choice is the right answer, although there’s a lot of play even there in terms of the details. In any case, much of the true answer will come via the labor market, now more than ever.

On that note, there are some statistics that are encouraging, albeit with all the usual caveats. Nonetheless, the upturn in the so-called hires rate in the economy provides a small bit of light in a dark tunnel. As the chart below shows (courtesy of the Labor Department), the new hires rate continues to rise off the bottom established in mid-2009. A pick-up in job creation, in other words, appears to be gaining momentum.



The problem is that the economy is still losing more jobs than it creates, i.e., the separations rate (the ratio of employment terminations to total workers employed) has been sticky on the upside. But the gap between hires and separations is closing. Is there enough momentum in the recent rise in new hires to overtake separations in the months ahead? Perhaps. If so, the shift will reflect a minor milestone in favor of growth.

Of course, we should be cautious in expecting too much too soon. Charles Thibault of Wanted Analytics considered the positive implications via a rise in new hires back in September. But the optimism, even though it was statistically warranted, was premature. The net change in nonfarm payrolls was still down in December.

Midway through the first month of 2010, there are enough headwinds facing the economy to keep our expectations in check. That includes the dire trend in the tally of the long-term unemployed (out of work for 27 weeks or more), which hit the highest rate since 1948, when data on this series was launched. Forty percent of the unemployed were jobless for 27 weeks or more last month, according to the Labor Department. “This is not your typical cyclical downturn where hiring is just postponed until business improves,” Richard DeKaser of Woodley Park Research tells the Christian Science Monitor. “This is really more about structural unemployment.”

The economic rebound faces “three significant headwinds,” Eric Rosengren, president of the Boston Fed, warned earlier this month: weak lending by banks, cautious consumers and a slow recovery in the labor market. “It appears that this recovery will likely experience only a slow improvement in the employment picture, and that the unemployment rate will remain quite elevated during the early phases of the recovery,” he said. “GDP growth is expected to be strong enough to produce some employment growth, but that rate of employment expansion will not likely be rapid enough to put a large dent in the unemployment rate.”

Even the most optimistic forecasters must face facts: It’s going to be a long year.

This post has been republished from James Picerno's blog, The Capital Spectator.

Thinking Backward Can Make You Miss The Rally In Gold

Moses Kim from Expected Returns is very bullish on Gold for 2010 and sees the recent slide in price as a short-term setback. By focusing on what can happen in the future rather than trading based on mistakes made in the past, investors can avoid missing the rally in Gold. See the following post from Expected Returns.

Gold is in the middle of a very healthy correction that has done nothing to alter the bullish trend in gold. The consensus seems to be that gold should correct considerably more, at least to the $1,000 dollar level. Even many gold bulls see much lower prices before the gold bull market resumes.

What happens often is that people trade based on what they wish they did before. For example, people who failed to short stocks during the epic collapse of 2008 were the same people trying to short stocks for the better part of this historic rally. In the same way, people who missed the huge move in gold are hoping for a huge correction so that they can buy shares. Unfortunately, the market rarely obliges hopes like this.

If we remove our emotions from our analysis for a second, we can see that gold is in a bullish consolidation mode. We are sitting right at the 50 day moving average, and the 200 day moving average has recently moved past $1,000 dollars.

Technically, gold needs to push past $1,150 dollars for the next phase of this bull market to begin. Above $1,170 dollars and we're likely to retest all=time highs in short order.





Shares Are Still Cheap

A useful measure of the relative cheapness of gold shares is the gold to xau ratio. As a general rule of thumb, a ratio above 4.0 is a strong buy signal for shares. The current gold to xau ratio of 6.5 is a level that has consistently produced year-long rallies of over 50% in the past. The past year should have been used to accumulate shares at cheap levels.




Gold shares were pressured by general market conditions in 2008, but they have recovered strongly. In the chart below, notice that gold shares are below all-time highs. It is hard for me to see how stocks that are trading at the same level of 2 year ago are a bubble.



I am very bullish on gold in 2010, and I believe $1,130 will look mighty cheap by the end of the year. There will be a number of surprises in 2010 in various asset classes from real estate to stocks and gold. When the economy starts to implode again in 2010, I expect gold to explode.

This article has been republished from Moses Kim's blog, Expected Returns.

China's Growing Influence In The Global Oil Market

Keith Fitz-Gerald from Money Morning discusses China's growing influence in the global oil market. With the country’s oil company PetroChina setting up shop in the Caribbean, and oil demand in the US slowing down, its influence on US oil prices will likely increase, underlining further the shift in power that is currently taking place. See the following article from Money Morning for more on this.

I bought a Toyota Prius last Saturday.

The signs are everywhere that oil is headed for stratospheric highs - $200, $250 or even $300 a barrel. Some of these signs are just plain obvious. But even the subtle indicators are telling us that some very expensive energy costs headed our way.

Let me tell you about one such indicator that I came across over the New Year holiday. A tiny news item said that Saudi Arabian oil concern Aramco is abandoning a lease on Caribbean oil storage, and further reported that PetroChina Co. Ltd. (NYSE ADR: PTR) is moving in to take Aramco's place.

Most investors here in the West - if they even read the item - would've dismissed it as just another minor business transaction, one among the thousands that take place each day. But this particular deal was much more than that. It's another indication of China's continued global emergence. And it also underscores this country's relegation to the growing legion of "former" world powers that have been eviscerated by the financial crisis that they created.

In case you missed the story, let me share the details, and then explain what I believe those details actually mean.

On the last day of the year, the state-owned Saudi Aramco walked away from a 5 million barrel storage capacity lease at the Statia Terminals Group NV facility on St. Eustatius Island in the Caribbean. Ordinarily that wouldn't be significant. After all, oil leases come and go - change is a normal part of doing business.

But two facts make this transaction different:

• First, Aramco had renewed this lease - which accounts for 38% of the total storage capacity on the island - since 1995 as a means of staging oil near its primary market: The United States.

• And, second, with Aramco's departure, PetroChina, China's state-run oil company, has opted to move in.

From a strict numbers standpoint, I grant you that a 5-million-barrel facility doesn't appear significant. That much oil will meet U.S. energy needs for all of about five hours. And it equates to less than 1% of the U.S. Strategic Petroleum Reserve, which holds about 726.6 million barrels of oil. So it's not like China will suddenly have a lock on the U.S. oil market.

So what gives?

The Saudis know that U.S. has peaked. The Prius - and hybrid vehicles in general - are no longer a novelty on U.S. highways. And though still inadequate, alternative-energy policies are finally gaining traction in Washington. Finally, U.S. consumers are getting smart: They aren't just going to stand passively by and just "take it" when oil reaches the $150-a-barrel level. They'll find additional ways to conserve, pushing demand down even more.

So Aramco is shifting its focus elsewhere.

In fact, the company is targeting China and India, the first and second-fastest-growing oil markets in the world, as measured by petroleum consumption. Aramco is actually using free-storage capacity that it recently acquired from Japan.

Now I grant you that the high growth rates from China and India are partly due to the fact that they are both starting from a small base. Even so, if you take the time to do a little bit of simple forecasting, a dramatic picture emerges. China's oil consumption is growing 12% a year. At that rate, China's annual oil use will equal or surpass that of its U.S. counterpart by 2018.

We're talking less than a decade from now.

U.S. energy demand peaked in 2005, according to Department of Energy statistics, and most recent forecasts say it's unlikely to ever return to those levels.

Saudi Arabia's oil shipments to the United States hit 22-year lows in 2009. And that situation is unlikely to reverse itself even if the U.S. economy bounces back this year and beyond. It seems as if a financial-crisis-induced recession and all rhetoric about reducing our dependence on foreign oil combined to do just that.

What this deal really signals is a global changing of the guard.

For its part, Aramco is making a calculated decision to "follow the money" (the same mantra we follow here at Money Morning, and at our monthly advisory service, The Money Map Report). In that company's view, the money trail leads to China. The facilities it snapped up in Japan are a mere three days sailing distance from Shanghai's busy ports.

Charles K. Ebinger, director of the Energy Security Initiative at the Brookings Institute, said the move is "purely a reflection that the world market is changing... [and the] Saudis want to make sure they don't lose those markets."

PetroChina, on the other hand, isn't buying a pig in a poke. The Beijing-based player is taking over what seems to be a somewhat insignificant storage lease in the Caribbean as part of a strategy that includes more than just serving the U.S. market. Indeed, China intends to increase its presence in South America, and is building a base for more oil deals south of the equator.

Mark my words: We will see additional Chinese oil firms headed for South America, and can expect some headline-making deals.

Not that China is planning to ignore, or even forget, the U.S. market. Just the opposite, in fact.

With this deal, PetroChina - and, by extension, China - will actually enjoy a bigger, and more direct, influence on the U.S. oil markets because of the trading leverage that stems from having physical delivery capacity located so close to our borders.

Factor in the futures exchanges in Shanghai, Shenzhen and Dubai that are growing in volume every day, and you can easily see what the next step will be in this evolution of the world energy markets. U.S. exchanges will see a decrease in their influence on oil prices; that influence will shift to exchanges that exist far from our shores - a point that I made repeatedly in my new book, "Fiscal Hangover."

For U.S. lawmakers and the rest of the inside-the-beltway crowd, this changing of the guard - and the fallout that's certain to result - will lead to some challenging times. With China now in the game, there's even a very real chance Washington will discover that it's been maneuvered at least to the sidelines, and perhaps even out of the game.

The bottom line here is that oil prices are headed higher. Much higher. The oil industry itself is likely to be very volatile in the next few years, so the escalation will be in fits and starts, and there will even be some periods of retrenchment.

But don't worry. Investors who accept this new reality will find plenty of opportunities to profit.

This post has been republished from Money Morning, an investment news and analysis site.

Why Natural Gas Is A Compelling Investment Right Now

Porter Stansberry, writing at Daily Wealth states that the future inflation and increasing interest rates make it a good time to invest in commodities and energy. In energy, he specifically likes natural gas which is replacing coal at power companies and is currently at a low price point of under $6 per thousand cubic feet. See the following from Daily Wealth for more on this.

In yesterday's DailyWealth, I outlined how rising interest rates will depress the stock market's P/E multiple... which will create a giant headwind for stock market investors.

You can protect yourself from this headwind by avoiding high-priced growth stocks. A popular growth stock trading for a P/E of 40 can get cut in half in a matter of months in this kind of environment. For instance, Amazon currently trades for 75 times earnings. Surgical device maker Intuitive Surgical trades for 58 times earnings. Danger ahead.

But what sectors do well when inflation is rising... when the government bond market is correcting... and when earnings multiples in the stock market contract?

Two things in particular: energy and precious metals.

In December 2008, just after witnessing the financial crisis and the government bailout of AIG, the investment banks, and Fannie/Freddie, I knew it was only a matter of time before we entered a market like we have today – one with rising inflation and interest rates. My first – and best advice – was to buy gold bullion.

I also noted how cheap gold stocks were at the time, and recommended buying GDX – the ETF of the unhedged gold producer companies. We bought at $28 per share. It was recently trading at more than $50 per share. I expect it to go much higher, but clearly, our best chance to buy gold stocks is long gone.

On the other hand, various market factors have pushed natural gas down to record low levels – offering us an attractive way to buy a great inflation hedge. It's worth considering what the world's best-managed oil company – ExxonMobil – is doing in this sector right now...

In mid-December of last year, ExxonMobil announced it would buy the largest U.S. natural gas producer, XTO Energy, in an all-stock transaction valued at $41 billion. This will be Exxon's biggest takeover since acquiring Mobil in 1999. The XTO purchase provides Exxon with reserves equivalent to 13.9 trillion cubic feet of gas, or 2.3 billion barrels of oil.

From 2005 to 2008, when most of the other Big Oil companies went on a buying spree, Exxon was selling assets and adding to its massive cash hoard. Just as easy lending led to the real estate crash, high energy prices (especially in natural gas) led oil companies to expand recklessly. They started investing in alternative-energy resources like shale, which cost more to produce.

In December 2005, ConocoPhillips paid $35.6 billion for the independent oil and gas company Burlington Resources. In January 2006, Royal Dutch Shell bought 70,000 acres of the Fayetteville shale property in Arkansas. BP paid nearly $2 billion for 90,000 acres of Chesapeake Energy's Woodford property in July 2008 – right near the top. BP paid another $1.9 billion for a 25% stake in Fayetteville just after the Woodford purchase.

All of these purchases took place while gas was trading near all-time highs. When the economy turned down in mid-2008, natural gas plunged from around $14 per thousand cubic feet (mcf) to less than $3. Big Oil's gas purchases got crushed. That's when Exxon made its move.

The reason Exxon is buying gas is simple... Oil is expensive to find. It's more cost-effective to buy cheap natural gas reserves. Gas has more than doubled from its 2009 low, but it's still down 70% from its 2005 highs.

The chart below shows the 15-year historic ratio of oil to natural gas. When the line peaks, gas is cheap relative to oil. When the line bottoms out, gas is expensive compared to oil. When gas prices bottomed in September 2009, the ratio jumped to more than 24. The current ratio is around 14. While we're not catching the exact bottom, we do have the opportunity to buy gas at one of its cheapest points relative to oil in history.



S&P 500: The stock market has gone to sleep

You can see that natural gas is cheap right now. And three main drivers will increase demand...

1. Domestically, power companies are switching a large number of coal-fired power plants to natural gas. As electricity demand rebounds this year, natural gas demand will rebound faster than expected.

2. In China, coal comprises 70% of the primary energy. Natural gas only makes up 3% of its primary energy. Eventually, out of health concerns for its citizens, China will depend more heavily on the much cleaner alternative – natural gas.

3. Finally, my friend Rick Rule, the hugely successful resource investor, points out that many national oil companies, like Venezuela's and Mexico's, have severely underinvested in their domestic oil production for years. As a result, they will suffer drastic production declines. Unless Iraq steps up its oil production in the next five years, Rick says we'll see "a catastrophic shrinkage in crude export availability." Natural gas can solve that problem, as well.

I predict these three macro factors will push natural gas to more than $10 per mcf this year. Natural gas is under $6 per mcf right now. It's time to be bullish on natural gas.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

How Washington Can Help The US Worker

As job losses continue and the unemployment rate remains high, the claim that the first economic stimulus package helped create long-term jobs is heavily disputed. Eric Jackson from The Street says that helping existing businesses remain competitive and thereby reducing the need for redundancies would be a better route to take. See the following post from The Street.

With last Friday's announcement that the economy lost another 85,000 jobs in the month of December and an unemployment rate still above 10%, renewed pressure is on the federal government to create jobs.

However, the truth is that it can't create any new jobs -- at least ones that are going to last beyond any short-term project. A new study shows the government's efforts had virtually no impact on changing the jobless rate.

We endlessly hear about the unemployment rate and the need for jobs. Many economists and politicians are now talking about the need for more jobs and a second stimulus. However, we need some clear headedness about this discussion.

What exactly can government do to fix this problem of too many unemployed or under-employed? I think the honest answer is not much directly or immediately. It can only create jobs in the long term and indirectly, through following policies that enable businesses to better compete.

The government passed a $700 billion TARP program to aid the country's financial institutions in the fall of 2008. By measure of the fact that all the big banks and brokers are still around today, with much of the money repaid to the American taxpayer, this program was a success.

We can quibble about whether the big banks such as Citigroup(C Quote), Bank of America(BAC Quote), and Wells Fargo(WFC Quote) are lending enough or how much Goldman Sachs(GS Quote) and Morgan Stanley(MS Quote) are paying their top performers, but the fact remains that these institutions are still standing today. We weren't so sure they would be 12 short months ago.

On the heels of the TARP program, the government passed a $789 billion first stimulus program. The money, although large, was seen by leading economists, the Federal Reserve chairman, virtually all Democrats, and many Republicans as necessary to reviving the struggling economy.

As of today, only half of this money has been spent ($400 million). The reason for this is that, even with the best of intentions, government can rarely directly inject money (and jobs) into an economy.

Politicians give primary importance these days to getting re-elected and the way to do this is through seeming to respond to the top needs of their constituents. When the first stimulus was passed, politicians could slap themselves on the back and say they'd addressed the problem of the weak economy. The press also moved on to other topics, rather than continue to follow up on just what this money had been spent on and how effectively that stimulus had resulted in jobs.

This week, the Associated Press, to its credit, did some investigative reporting. It looked at specific construction projects that were part of the first stimulus and how well they did at creating jobs -- and reducing unemployment -- in those counties. It turns out -- and their findings were validated by five economists -- that there was no correlation between dollars spent and those counties seeing a lower unemployment rate.

The president and his team continue to point to 1.6 million as the precise number of jobs which the first stimulus is responsible for saving or creating. However, the AP found that most economists agreed that it was virtually impossible to tie monies spent as part of the 400-page law to specific job outcomes in order to be able to cite a specific number of jobs created or saved.

The White House has also recently determined that they can identify certain jobs as being "stimulus-saved jobs" even if they were never at risk of being lost.

When it comes to coming up with new projects, such as repairing roads, it might take months from the time a bill is passed until a job actually begins -- and that's assuming that there are delays from zoning or other planning requirements, which is more often the case. Even when these government-sponsored projects start and jobs are created, they are so insignificant when compared to the other jobs that are being lost in those same areas.

Here are implications from this one study, as we prepare to hear politicians sell us on the idea of a second stimulus.

• Just spending billions of taxpayer dollars on government programs that aren't defined is likely to be a wasted effort.

• We should only spend money in areas which have been shown to clearly make an appreciable difference to lowering unemployment.

• If you're going to start a construction project, it should have a definable purpose (as opposed to the "bridge to nowhere") and it should start immediately, not three years from now.

• State support is likely (although, again, I've seen no hard studies on this) one effective way of keeping real jobs. Many states and counties are simply running out of money at the moment. If the federal government can keep a police officer on the job, where he or she would otherwise be unemployed, that's a tangibly positive outcome.

The federal government should be intellectually honest that it can do little to actually create jobs (at least permanent ones). Instead, its role must be to continuously support businesses to feel confident enough to create jobs themselves. At the moment, that confidence is lacking.

The honest truth is that I don't know how to help a 55-year-old father of five from Lexington, Ky., who just lost his manufacturing job, find his next job. He's probably not going to get "retrained" by the government and find another manufacturing job easily. He's certainly not going to be first in line to get one of the exciting-sounding "green jobs." I don't think any politician -- Republican or Democrat -- has any idea of what to do to help this guy.

But there are a lot of people like this out there today -- too far along in their careers to restart, with too little money to retire.

This guy is realistically on his own to find his next job. He needs a government to help increase the safety net of services like food stamps to help, and one to help businesses across the country to feel more confident, but he doesn't need another stimulus program that the politicians congratulate themselves about which leads to nothing for him.

This post has been republished from The Street.

Job Trends Suggest Start Of Slow Recovery

James Picerno says that the downward trend in initial job claims and continuing claims show that a slow economic recovery has started. However, the economy is not expected to roar back like recent post-recession periods, but could instead settle on a new normal in the second half of 2010. See the following post from The Capital Spectator.

No one should doubt that an economic recovery is underway. But no one should assume that the rebound is robust or destined to quickly bring economic healing on a broad scale. It's different this time.

The trend, at least, remains positive on a number of metrics, including the latest numbers on workers filing unemployment claims last week for the first time. New jobless claims rose 11,000 last week to 444,000, the Labor Department reports. But as our chart below suggests, the latest data point is statistical noise. The declining trend, in short, remains intact.



Since peaking in March 2009, weekly jobless claims have been on a steady downshift. As we’ve written many times, starting with this piece from early last year, a sustained decline in this measure bodes well for an upturn in the economic cycle. We’ve been arguing for some time now that the downshift in jobless claims has legs and so the natural forces of recovery are set to grow stronger. The latest report on this front offers no reason to change our view for the near-term future.

Confirming the trend is the update on so-called continuing claims, which measures the number of workers who've been receiving unemployment benefits. This tally is also falling, as our second chart below shows. For the week through the first of the year (the latest number available on this data series), continuing claims were just under 4.6 million, a drop of 211,000 from the previous week and the lowest in almost a year.



These two trends, along with a range of other metrics we routinely follow and analyze in The Beta Investment Report, tell us that there’s a rebound underway. This isn’t necessarily surprising. Indeed, we’ve been anticipating no less on these pages for some time.

To be honest, forecasting an end to the recession and a rebound of some degree required no great powers of prognostication in the recent past. Although some were skeptical, we’ve been of a mind that the usual course in economic history would reassert itself once more. So far, so good. But as we’ve also been advising all along, the recovery is likely to be weak, particularly on the variable that matters most: job creation. The latest news on employment suggests no less. Another major sore point on looking ahead is the weakness in lending.

The danger is that the recovery process is at risk of faltering. But not yet, thanks to the organic forces of economic recovery, supported by the still-extraordinary degree of monetary stimulus. The combination is still quite potent (labor and lending being the primary exceptions). Nonetheless, the first test of the new normal will come in the second half of 2010, or so we believe.

In most post-recession periods of recent generations, the labor market came roaring back, albeit in lesser degrees in recent years. But for a number of reasons, that's not likely this time. In any case, much will depend on how the trend in job creation fares in the coming months and quarters. For the moment, the good news is that the layoffs are receding and the ranks of the unemployed are no longer climbing. In fact, we expect that the jobless rate will turn lower in the months ahead, if only marginally. But the big test is still ahead of us.

The transition this time from an economic climate that's no longer destroying jobs to one that's generating new positions of some magnitude is likely to be rocky. It’s not yet clear how much job-minting capacity is coming, but we’ll find out soon. For what it's worth, our expectations are muted relative to past cycles.

This post has been republished from James Picerno's blog, The Capital Spectator.

10 Predictions For Investors In The New Decade

Tim Iacono predicts a bumpy ride ahead for investors with home values declining further and the dollar continuing to weaken, while stocks are likely to relapse and unemployment to remain high. If the economy continues to sputter, we could see major changes in who is elected to office this fall. See the following post from The Mess That Greenspan Made.

This year's prognostications come a bit later than usual - about two weeks - however, don't think for a second that the delay was used to "game the system" by allowing time to review what other seers think 2010 will bring.

After having read a few of these, it quickly became more confusing than when the process first began a couple weeks back and I now regret having opted to nurse a slight hangover and watch football on January 1st rather than knocking this out as has been the routine in recent years.

Even without a plethora of other opinions, seeing into 2010 has proven to be much more difficult than looking ahead into 2009 a year ago, simply because, after the events of late-2008, conditions couldn't get much worse - they had to get better.

This is clear to see in the Predictions for 2009 made 54 weeks ago and then discussed in last week's follow-up A Review of 2009 Predictions where a rebound from the dismal 2008 results occurred for the economy, financial markets, and my own forecasting performance.

As for the new year, some things seem certain, others not so much.

Off we go...

1. Maybe the Last Really Bad Year for Housing

It's hard to understand how anyone can really think that the nation's housing market managed to "stabilize" in 2009 when prices continued to decline on a year-over-year basis even after government support to this sector on a scale never before seen by Mankind.

Homebuyer tax credits, central bank purchases of mortgage-backed-securities, a sharp increase in FHA lending, and a host of other factors have merely "kicked the can down the road" and that road will be "uphill" in 2010. Mounting foreclosures, loan resets, and an increasing number of homeowners who simply "walk away" from underwater mortgages will cause a relapse in housing this year and month-to-month gains will turn back to losses.

As measured by the 20-city S&P Case-Shiller Home Price Index for October 2010 (to be released in late-December), home values will decline by another 8 percent. The U.S. government will extend the homebuyer tax credit again in the summer and late-2010 will be a good time to start looking to buy property in most parts of the country.

2. The Dollar Will Continue its Descent

The dollar fell modestly last year after a surprisingly strong 2008 and it will continue that slow, steady decline in 2010 after a surge of safe-haven buying in the spring after equity markets have another little hiccup, temporarily boosting the greenback's appeal.

The trade weighted dollar ended 2009 at about 78 but will end 2010 at 72 after briefly dipping into the 60s and scaring the bejeezus out of the entire world as the long-anticipated "global currency crisis" once again looks like it is at the world's doorstep.

The dollar weakness will be driven primarily by concerns about funding the U.S. budget deficit as traditional buyers become more scarce and the entire world begins to realize that the economic recovery in the U.S. will be very long and very slow.

3. Stocks Will End the Year Lower

Broad equity markets in the U.S. will advance early in the year and then, peering into the future of the domestic economy and not liking what they see, have a relapse right along with the housing market.

Retail investors will continue to pull money out of stocks, in the process muttering Will Rogers' famous words about the relative concern for the words "of" and "on" when they are placed between the words "return" and "principle". Whatever or whoever drove stocks higher in 2009 will have much less success doing so in 2010, however, it won't be a complete washout as the Dow will lose 10 percent and the Nasdaq 15 percent.

Stocks in China will get about half-way back to their 2007 highs before reversing and ending the year only modestly higher. Gold and silver mining stocks will fall in sympathy with other equity markets but will rebound faster and end higher than most other sectors.

4. Short-Term Interest Rates Will Stay at Zero ... Again

Like last year, short-term interest rates in the U.S. will end where they began - at zero - but the central bank will tack another $1 trillion onto its balance sheet.

Chairman Ben Bernanke will be re-confirmed for another four-year term as Fed chief but will receive the highest number of 'No' votes in history and many elected officials voting 'Yes' will regret their decision by summer as the economy sours and the mid-term election nears.

The Fed will stop buying mortgage backed securities in March and the housing market swoon will intensify. Bernanke and crew will then resume their purchases in May because no one else was willing to buy at anywhere near what the central bank was paying.

5. Energy Prices Will Go Up and Then Down

After rising to $95 a barrel during the spring, the price of crude oil will dip to as low as $45 and then end the year at $65 a barrel. Peak oil will have to wait until global growth begins to post much bigger numbers and that won't happen this year.

The price at the pump will rise from their current $2.70 a gallon to more than $3 a gallon early in the year and then retreat back to the low $2 range. Gasoline was one of best commodity investments last year, this year it will be one of the worst.

None of the green energy job initiatives will amount to anything and that's just sad.

6. Gold and Silver Will Soar ... Again

The end of 2010 will mark ten straight years that gold bullion has ended higher than it began and most Americans still won't own it, continuing to put their trust in the mainstream financial media that, for the most part, still doesn't understand it or recommend it.

The yellow metal will make new all-time highs at just over $1,400 an ounce in March and then begin its every-other-year 18 month consolidation, ending 2010 at $1,300 an ounce. Silver will rise to $24 an ounce in the spring and end the year at $21 an ounce.

An increasing number of retail investors will eschew the advice of Money Magazine and buy gold and silver anyway, but a good number of them will sell it over the summer when metal prices correct. They'll be back in 2011.

People will start talking about junior mining stocks at cocktail parties - just like internet stocks in 1997. (As noted the last couple years, I'm going to keep saying this until it's true).

7. The U.S. Economy will Barely Avoid a Double-Dip

Economic growth will stall by the second quarter as Congress finds it politically difficult to make additional stimulus funds available during an election year. Following an impressive growth rate during the fourth quarter of 2009, the first two quarters of the year will see rates of between zero and one percent with the economy posting a small negative number in the third quarter.

The overriding theme in the economy during 2010 will be the continuing revival of a more frugal lifestyle following the credit and consumption binge of recent decades and the savings rate will continue to rise, from about 4 percent in 2009 to 7 percent by year-end, still well below the pre-Reagan administration average of about 10 percent.

8. Inflation will Surprise to the Upside

Consumer prices will rise much more than most economists expect early in the year driven higher by continuing unfavorable year-over-year energy price comparisons and the government's "official" annual inflation rate will reach a peak at over three percent as the grass starts turning green.

Then commodity prices will plunge and we'll start hearing about de-flation again.

9. Only a Few Jobs will be Created

Next month's benchmark revisions to the Labor Department nonfarm payrolls data will show an additional loss of 1.2 million jobs during the early-2008 to early-2009 period (greater than the currently estimated 840,000 loss) and there will be only modest net job growth in 2010 of about 500,000 jobs, all of it in health care.

The unemployment rate will reach a peak at 11 percent early in the year and remain above the 10 percent mark during all of 2010, save for a two-month dip in late-summer as millions of jobless become discouraged and stop looking for work.

10. The 2010 Elections will Be Shocking

As the economy turns from weak to bad again over the summer, there will be some surprising developments leading up to the fall elections as young and old alike express their displeasure with the status quo, namely, the cozy relationship between elected officials and the leaders of the FIRE (Finance, Insurance, and Real Estate) economy.

A record number of independents will run for and be elected to office and Washington will start to get the message, but Wall Street won't.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

5 Reasons That The US Economy Is Far From Recovery

Moses Kim discusses factors that indicate that the US economy is far from being out of the woods. Rising energy costs, ongoing contraction of consumer credit, and a very weak labor market are just a few of the factors that weigh heavily on consumers and businesses alike. See the following post from Expected Returns.

I think we are past the period when economic indicators and company earnings surprise to the upside. Case in point, Alcoa's big earnings miss yesterday. Forward earnings estimates for 2010 are in the stratosphere, which means surprises will come on the downside.

As we move ahead, here are some key economic trends that will determine whether our economy recovers or not in 2010.

Rising Energy Costs

We all remember the economic dislocations rising energy costs brought in 2008. Job losses were just beginning, yet consumers were hit hard by high energy costs. Consumers received a temporary and much-needed reprieve from high energy costs as crude oil collapsed to $33 dollars a barrel. However, crude oil has rallied over 100% in a little over a year, which means consumers are getting wacked again at the pump.

Demand for crude oil is relatively inelastic, meaning consumers are going to bear the brunt of price spikes. With gasoline prices approaching $3 dollars a gallon, discretionary spending is going to be seriously constrained moving forward.

Trade Deficit Growing

The government announced yesterday that the November trade deficit increased. The economic spin is that rising imports reflect an economy that is on a strong upward trajectory. However, digging beneath the report we see the following:

1. Crude imports are at the lowest level since February 1999

2. 7.3% rise in petroleum import prices in November

3. $72.54 average per barrel cost- highest since October 2008

The collapsing imports of crude oil strongly evidence an economy that is weakening. If crude oil prices remain elevated in the $70-$80 dollar range, I expect consumer spending to fall sharply.

Consumer Credit

In November, consumer credit contracted for the 10th straight month to the tune of a record $17.5 billion dollars. This is a historic contraction of credit that trumps the credit contraction during the Great Depression. The Fed is turning on the printing presses to counteract this credit contraction, but as the massive rise in commodity prices shows, with most commodities up over 100% YoY, the massive reflationary programs of the Fed have consequences.

Weak Labor Market

The surprisingly weak December unemployment report with the recent report that job openings declined by 156,000 in November. Firms are still reluctant to hire, and this holds especially true for small businesses.

Small Business Optimism Falling

Small business optimism dropped again in December, and remains at recessionary levels. The report shows that small businesses are losing pricing power in this abnormally weak economic environment, which means profit margins will remain low along with new hirings.

Small businesses will be absolutely critical to any economic recovery. We just aren't seeing the kind of optimism we need to see from a sector that accounts for over half of the jobs in America. Many small businesses have seen their access to credit disappear, which has forced small businesses into cost-cutting measures. With not much margin of error left, small businesses will start going bust if the economy doesn't improve quickly.

Conclusion

There is no recovery. Rising energy costs in particular should be enough to bring about a double-dip recession in 2010. Pretty soon, it will be hard for the government to conceal the true state of the economy, which at the very least, is still at recession levels.

This post has been republished from Moses Kim's blog, Expected Returns.

Could The Government Take Away Individual Control of 401(k) Savings?

A government proposal would take away some control of 401(k) by requiring retirees to convert some of their savings to annuities although 70% of US households oppose it. Whether this controversial plan would give retirees the hoped for security is however doubtful. See the following post from Expected Returns.

Our government is in the middle of a funding crisis that will be resolved as it always has: through the confiscation of citizens' hard-earned wealth. Judging by the way Americans are being conditioned to accept criminal behavior at the highest levels of government, this confiscation will probably be pretty explicit. I'm guessing we'll eventually see a FDR-style confiscation of gold and retirement accounts (401(k)'s). From the following article in Businessweek, Americans Oppose Initiatives Limiting 401(k) Choices, ICI Says, it seems that day is quickly approaching.

U.S. investors oppose federal initiatives that would force them to give up control over their 401(k) accounts, the Investment Company Institute said.

Seven in 10 U.S. households object to the idea of the government requiring retirees to convert part of their savings into annuities guaranteeing a steady payment for life, according to an institute-funded report today.

7 out of 10 Americans against government control of 401(k)'s? This probably means legislation is going to be shoved down our throats anyway. I mean, isn't this the new trend in our new "government-knows-best" style of government?

Annuity Conversion, aka Theft

The U.S. Treasury and Labor Departments will ask for public comment as soon as next week on ways to promote the conversion of 401(k) savings and Individual Retirement Accounts into annuities or other steady payment streams, according to Assistant Labor Secretary Phyllis C. Borzi and Deputy Assistant Treasury Secretary Mark Iwry, who are spearheading the effort.

The coming theft of retirement accounts is one of the most obvious trends for the next 20 years. I mean seriously, the American public stood shell-shocked like 5 year olds while getting looted to the tune of trillions of dollars- what makes you think the government isn't going to steal your retirement accounts?

The government is going to try to sell the move into annuities as a "safe" way to protect the public from the vagaries of the stock market. The truth is, the government is damn broke, which means they will have their hand in every person's pocket. The confiscation will function like this. American citizens will be forced to buy a worthless asset (in this case U.S. Treasuries) and receive a paltry return on capital. Factoring in inflation, returns are likely to be negative.

That the government has to resort to such measures indicates the severity of the current funding crisis. First, the insane monetization of debt. Now, Americans will be compelled to prop up the Treasury market. 5 years ago you couldn't make this stuff up; today, it is a reality.

Stock Market Collapse + Retirement Hopes Destroyed

Ok. So the government is basically telling us they are going to confiscate 401(k)'s. Now think for a second what happens when massive forced inflows of capital into stocks turn into massive forced outflows. It doesn't take a genius to figure out stocks are going to crater, and with it, the retirement hopes of millions of Americans.

When a critical mass of the population realizes this, then you will really know what a panic is.

401(k)’s were always structurally deficient products. The standard line is that with tax benefits and company matches, nothing can possibly go wrong! 401(k)'s are for the "wise" investor who is in it for the mythical "long-term". Whenever I hear this ridiculous line from someone, I know the person hasn't looked at a single "long-term" chart in his life. Sorry to ruin the party, but in the "long-term" (at least for Baby Boomers) stocks are going to go down in real terms and taxes are going to rise. And oh yea, you're getting taxed on earned income, which means if your 401(k) is actually worth something, the only person who will be celebrating is Uncle Sam. This is a disaster in the making for the disappearing middle class in America.

2010-2020: Major Paradigm Shifts Coming

These are interesting times. I can tell you this much: a lot of paradigms are about to change in the next 10 years. Most people are already skeptical of our government, which is clearly evidenced by the plunging approval ratings of both Congress and President Obama. However, most people are ignorant about the lengths governments always go to in order to prevent insolvency.

The current forced bond purchase scheme by our government reminds me a lot of what happened in France during the French Revolution, when church property was confiscated in return for assignats- which functioned as bonds. It didn't take long for those assignats to be worthless in value. I expect the same thing to happen eventually with U.S. Treasuries.

There will be a crisis of sorts in the near future. This is just one of the many reasons I am extremely bullish on gold.

This post was republished from Moses Kim's blog, Expected Returns.

Who Is Most Responsible For The Housing Bubble?

Despite Bernanke's attempts to avoid blame for the housing bubble, economist Mark Thoma explains why it was a combination of failures by the Fed and regulators that led to the bubble and crash. The Fed fueled the fire by providing excessive liquidity in the financial system, while regulation failed to recognize systemic risk and control the spread of the damage. See the following post from Economist's View.

In response to the question of whether the Fed's low interest rate policy is responsible for the bubble, most respondents point instead to regulatory failures of one type or another. Ben Bernake has also made this argument. However, I don't think it was one or the other, I think it was both. That is, first you need something to fuel the fire, and low interest rates provided fuel by injecting liquidity into the system. And second, you need a failure of those responsible for preventing fires from starting along with a failure to have systems in place to limit the damage if they do start.

Bank regulators didn't have the systems in place to prevent bubbles, they didn't see the bubble developing until it was too late to prevent major damage, and the systems needed to limit the damage were inadequate, e.g. there were insufficient limits on leverage and other protections in the system. By analogy, the Fire Department's inspections were inadequate and there was much more fire risk than anyone thought, they didn't notice the fire until it was already out of control (even though Dean Baker and others had tried to alert them), when they did notice and respond they were initially confused and didn't have the tools they needed to fight the fire or prevent it from spreading, and they hadn't thought to require protections such as automatic sprinkler systems that might have limited the damage.

What fueled the housing bubble? There were three main sources of the liquidity that inflated the bubble. First, the Fed's (and other central banks') low interest policy added cash to the financial system, second, the high savings in Asia, particularly China, along with cash accumulations within oil producing nations, and third, some of the cash was generated endogenously within the system (e.g. by increasing leverage or by diverting other investments into housing and mortgage markets).

Once the fuel was present, something had to allow the bubble to inflate and then do widespread damage, and that's where the regulatory failure comes in. But I don't think the regulatory failure matters much without a large amount of liquidity within the system, and I don't think the large amount of cash in the system is problematic without the regulatory failures.

I've been making this argument for some time, so is there any support for the idea that bubbles are fueled by excessive liquidity? In the video embedded below of Nobel prize winning economist Vernon Smith that posted today at Big Think (http://bigthink.com/ "Dissecting the Bubbles"), he notes that in the experiments he has conducted that reproduce bubbles in the lab, the existence and size of bubbles depends critically upon the amount of "cash slopping around in the system."

In the video, he also notes that if you ask a different question, why was this bubble so devastating as compared to the dot.com bubble even though the initial losses were smaller -- $10 trillion in 2001 compared to $3 trillion in the housing bubble collapse -- you get a different answer: a failure of regulation. Here, he points to a failure to impose sufficient margin requirements as the key difference between the two episodes (I agree that leverage should be limited through margin requirements, and this would have helped to contain the damage, but I would have focused on the markets for complex financial assets rather than down payments on homes).

So I think the bubble itself was driven by "cash slopping around in the system" that originated from several sources, the Fed being one, and the regulatory failures (such as failing to provide sufficient transparency so that the smoke from the fire could be spotted in time, and failing to limit leverage) allowed the fire to spread rapidly and do major damage.

This post has been republished from Mark Thoma's blog, Economist's View.

Bernanke Receiving Heat From Prominent Economist

Prominent economist John Taylor has taken issue with what he explains is a flawed argument by Bernanke on the use of low interest rates preceding the economic collapse. The co-creator of the Taylor Rule, which Bernanke attempted to alter to defend low interest rates, points out several holes in his argument. See the following from The Mess That Greenspan Made.

Around here, with only a few exceptions, there is nothing more exciting than a public spat between two economists and when it's the world's most important economist in Fed Chief Ben Bernanke and Stanford University Professor John Taylor, co-creator of one of the most hallowed rules in economics - The Taylor Rule - it just can't get any better than this.

In an opinion piece in today's Wall Street Journal, Taylor is clearly seething at the liberties taken by the Fed chief in a speech a week ago that used the Taylor Rule in support of arguments that interest rates were not "too low, for too long" a few years back.

My critique, which I presented at the annual Jackson Hole conference for central bankers in the summer of 2007, is based on the simple observation that the Fed's target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom.
...
In his speech, Mr. Bernanke's main response to this critique was to propose alternatives to the standard Taylor rule—and then to use the alternatives to rationalize the Fed's policy in 2002-2005.

Now, keep in mind that economists are normally mild-mannered fellows, so, you don't expect to see things like ALL-CAPS or profanity (particularly when WSJ editors are involved), so this is about as extreme as you can imagine ... there were likely little wisps of steam coming out of Taylor's ears as he finished that last sentence above, and understandably so.

Collecting himself as necessary, Taylor moves on to the specifics of his rebuttal, which, even for a non-economist seem to make good sense:

In one alternative, which addresses what he describes as his "most significant concern regarding the use of the standard Taylor rule," he put the Fed's forecasts of future inflation into the Taylor rule rather than actual measured inflation. Because the Fed's inflation forecasts were lower than current inflation during this period, this alternative obviously gives a lower target interest rate and seems to justify the Fed's decisions at the time.

There are several problems with this procedure. First, the Fed's forecasts of inflation were too low. Inflation increased rather than decreased in 2002-2005. Second, as shown by economists Athanasios Orphanides and Volker Wieland, who previously served on the Federal Reserve Board staff, if one uses the average of private sector inflation forecasts rather than the Fed's forecasts, the interest rate would still have been judged as too low for too long.

Third, Mr. Bernanke cites no empirical evidence that his alternative to the Taylor rule improves central-bank performance. He mentions that forecasts avoid overreacting to temporary movements in inflation—but so does the simple averaging of broad price indices as in the Taylor rule. Indeed, his alternative is not well defined because one does not know whose forecasts to use. Moreover, the appropriate response to an increase in actual inflation would be different from the appropriate response to an increase in forecast inflation.

If this were one construction worker reprimanding another it would surely be an expletive-laced, face-jutting-out-over-the-top-of-the-chest, top-of-the-lungs scolding of that other construction worker's failings, but, since these two are economists, you get critiques such as "no empirical evidence" instead.

Taylor is much more peeved about what Fed chief Ben Bernanke did last week than the casual reader might glean from this commentary. Then again, he is an economist, and it is not at all clear that economists have emotions like the rest of us.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Shielding Your Portfolio From Inflation With Gold

For thousands of years gold has been regarded as a reliable currency that is resistant to inflation. Especially in times of crisis and fear, the demand for gold tends to rise as currencies are debased. See the following article from Commodity Online for more on this.

Too much is written about gold these days simply because the yellow metal price has been on a steady rise for the last one year. When gold touched $800 per ounce in January 2009, investors and gold bugs applauded, hailing the precious metal as the best investment asset that people should hold and continue to own.

From $800, gold has been rising to the cheers of investors, central banks, bullion traders and gold enthusiasts. So when the yellow metal reached a peak of $1,227 per ounce in November 2009, there was delirious clapping from gold bugs and bullion analysts who said the next stop in the golden journey of the yellow metal was $1,500 and then it would head toward $2,000 per ounce. Since then gold price has stabilized around $1,100 range, and everyone is waiting for the next big move.

What is that is luring all and sundry to the glittering metal? Is it more precious and valuable than the real estate you buy in upcoming developing nations like China and India? Is it bigger asset than the money you safely put in the bank with nominal interest? Is it more secure that the variety of life and other insurance policies that are available in the market? Or is gold more precious than other metals like silver, copper, diamond, platinum, palladium etc?

Why are central banks building up gold reserves? Is it because gold offers a better foreign exchange asset than US dollar or other currencies?

The answer to all these questions can be summarized in two words—currency and inflation. Gold is currency in the modern world. Gold is the best hedge against rising inflation for many countries.

I came across an interesting article on gold as currency and inflation hedge in inflationdata.com. Here are some extracts from this site on how the prominence of gold is rising along with the price rise in the yellow metal:

Historically, gold and money have been pretty much synonymous so pure Gold was immune from inflation. But that didn't stop currency inflation. In the early days kings discovered that they could "extend" their money supply by adding just a bit of lead to the melting pot.

Unfortunately, as the percentage of lead increased the value of the coins decreased causing the first cases of inflation. (And also creating the habit of biting coins to see how soft they were and thus how much lead they contained). Egyptian Pharaohs issued the earliest gold coins, around 2700 B.C. But they were primarily as gifts for friends and not for commerce. It wasn't until (560-546 B.C.), that King Croesus of ancient Lydia began issuing Gold coins for general circulation. (Incidentally after 2500 years, the saying "rich as King Croesus" is still floating around).

Incidentally, every country that has employed fair Gold coinage has prospered while those that inflated their coinage with "base" metals failed. One example is Spain.

During the time that Spain was issuing their famous "pieces of eight" it was a world "superpower" but lost that status as it debased its currency.

See the rest of this article at Inflationdata.com

This article has been republished from Commodity Online. You can also view this article at Commodity Online, a commodity news and analysis site.

What Is The True Unemployment Number?

The US Bureau of Labor reports an unchanged unemployment rate of 10% for December, but just how accurate is this number? When we add the pushed-aside category of unemployed people who have given up looking for work and the involuntary part-time workers to the equation we arrive at a much more realistic figure, and it’s not a pretty picture. See the following post from Expected Returns.

This is a very weak unemployment report as every important qualitative measure of unemployment showed further weakness. There is no recovery based on the data. From the Bureau of Labor Statistics:

Nonfarm payroll employment edged down (-85,000) in December, and the unemployment rate was unchanged at 10.0 percent, the U.S. Bureau of Labor Statistics reported today. Employment fell in construction, manufacturing, and wholesale trade, while temporary help services and health care added jobs.

This is the official line. Let's take at a look at some of the statistical manipulation needed to come up with a 10% headline unemployment number.

Civilian Labor Force

The civilian labor force participation rate fell to 64.6 percent in December. The employment-population ratio declined to 58.2 percent. (See table A-1.) The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) was about unchanged at 9.2 million in December and has been relatively flat since March. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job.

The civilian labor force participation rate continues on its remarkable and historic downward trajectory. In order to appreciate the significance of such a contraction, it is critical to understand what the civilian labor force participation rate represents.

The civilian labor force participation rate represents the percentage of eligible, working-age individuals actively seeking work- which means looking for work in the past 4 weeks. If you haven't looked for work in the past 4 weeks, you are no longer considered unemployed in the government's land of make-believe.

Now, let's try to get a sense of how bad the unemployment situation is in what the average person would call reality, and not the land of government statistical make-believe. Curious minds will be asking why the civilian labor participation rate is declining at such a rapid pace. The answer lies in the protracted nature of the current economic downturn. From the BLS:

Among the unemployed, the number of long-term unemployed (those jobless for 27 weeks and over) continued to trend up, reaching 6.1 million. In December, 4 in 10 unemployed workers were jobless for 27 weeks or longer.

It's pretty clear that when 4 out of 10 individuals are unemployed for more than 6 months, we are talking about an environment where employers are simply not hiring. When employers stop hiring, people give up looking for work, which means they are no longer part of the civilian labor force. This individual is not considered by the government as unemployed, but as a 'marginally attached worker'.

About 2.5 million persons were marginally attached to the labor force in December, an increase of 578,000 from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

Below is a graph of 'discouraged workers', a subset of marginally attached workers, which represents those who want work, but are not actively seeking work due to perceived weak economic conditions. I like to think of the 'discouraged worker' as an indicator of current hiring conditions. If employers are really hiring, the discouraged worker should disappear rather quickly; instead we are experiencing a continued and relentless upward trend in this category of worker.


True Unemployment Rate

I think most of us can agree that the 2.8 million 'marginally attached' workers are in fact, unemployed. If we add the 2.8 million marginally attached workers to the labor force and consider them as unemployed, we get a 11.6% unemployment rate.

Now let's incorporate what we know about marginally attached workers and the civilian labor force to come to a truer unemployment rate. Let's assume for a second that the labor participation rate is at the 67% level we saw in the beginning of the decade and see the effect this has on the unemployment rate.

This will require some simple mathematics.

The current labor force is 236,933,000. An increase from the current 64.6% labor force participation rate to 67% would be met by an attendant rise in labor participants from 153,059,000 to 158,745,000. So about 5.7 million people would be added to the labor force. If we assume the labor force participation rate declined because of an increase in marginally attached workers (unemployed for less than 12 months) and other forgotten individuals (unemployed for more than 12 months), we come up with an effective unemployment rate of 13.2% .

So, the true unemployment rate -which I define (as I think most would) as ALL people who want work but just can't find it- probably lies somewhere between 11.6% and 13.2%. If you consider individuals working part-time for economic reasons as unemployed, you get an unemployment rate north of 17.4%.

In short, the unemployment situation is a lot worse than government statistics would suggest, and this weakness will eventually be reflected in our economy.

This post has been republished from Moses Kim's blog, Expected Returns.

The Case For A Strong Employment Recovery

Barbera and Weise suggest the possibility that jobs could rebound quickly because firms cut too many jobs in the panic of the financial turmoil of late 2008 and will need to rehire as they increase inventory levels. However, Mark Thoma disagrees with their recommendation to provide minimal stimulus while waiting for the possibility of better than expected hiring. See the following post from Economist's View.

An argument that we don't need a "a major new stimulus program" devoted to job creation:

A job-rich US recovery is still plausible, by Robert Barbera and Charles Weise, Commentary, Financial Times: Only one short year ago, the world was staring depression in the face. Now the economy is recovering, but many commentators are warning of a “jobless recovery” of the kind that followed the last two recessions, in 1990-91 and 2001. ...

We believe that these meager expectations will turn out to be wrong, in large part because they mischaracterize how employment has swooned over the past two years. ... Our more optimistic outlook is based on a ... theory of why payrolls were cut so aggressively. Because of the turmoil in financial markets in autumn 2008, companies faced a severe cash crunch. As a result, they attempted to hoard cash in any way they could: they slashed order books, ran down inventories at an unprecedented pace and cut short-term borrowing. And they slashed payrolls. The drastic reduction in inventories and payrolls was not, in other words, a result of restructuring: it was symptomatic of panic, the same panic that caused the massive sell-off in equities, corporate bonds and mortgage-backed securities. ...

Nearly all projections for the US economy envision a sharp reversal for inventories in the coming quarters. We argue that the recovery in jobs should mirror the restocking of inventories because the collapse in employment and inventories during the recession had the same source in panic-driven cash hoarding. ...

The same logic can be applied to productivity. Using consensus expectations for current-quarter real GDP we estimate that the last three quarters of 2009 registered an average rate of advance in labor productivity of almost 7 per cent. We estimate that productivity is now above its normal level, so reversion to the mean over the next year implies a productivity growth rate substantially below trend.

The following scenario then appears quite plausible. Real GDP grows at a rate of 3.8 per cent in 2010, with productivity growth of 0.7 per cent and a modest increase in average weekly hours. In such a world, employment growth would average 2.2 per cent. This translates to an average of about 240,000 jobs per month.

This scenario, while wildly optimistic compared with current consensus forecasts, amounts to a weak recovery by historical standards. In the first full year of recovery after the 1981-82 recession, GDP growth was more than 7 per cent. Following the recession of 1974-75, growth was 6 per cent. It is not hard to imagine growth over the next year well in excess of our 3.8 per cent forecast, with jobs growth in the 300,000 per month range. We are not endorsing that as our forecast but we believe it is as likely as the jobless recovery predictions that define the conventional wisdom.

Barack Obama therefore needs to be patient. A modest fiscal stimulus focused on aid to the states would be a helpful insurance policy against a further weakening in the economy. But the trends are in the administration’s favour, and a major new stimulus program should be resisted. ...

They're not even willing to "endorse" their own forecast? They do implicitly define a forecast since they say the optimistic and pessimistic outcomes are equally likely. So why does a 50-50 chance that there will, in fact, be a intolerably slow recovery in the job market mean we should stand by and do nothing while we hope the coin comes up heads rather than tails? The average of the two forecasts - the most likely outcome by their reckoning - is not very rosy for labor and calls for something to be done.

There are lags between policy changes and changes in employment, and that means it's much easier to back off of action initiated now if things turn out to be better than expected than it is to do something later if the optimistic scenario fails to materialize. That is, the risks of failing to do anything and then realizing the pessimistic high unemployment outcome are much larger than doing something now and then having things turn out better than expected. Even on their own terms, I don't think their conclusion that we shouldn't devote any resources to job creation (other than protecting jobs through "modest" help for state and local governments) follows.

In any case, Dean Baker countered the part of the argument related to productivity before it was even made. Here's his response to similar claims about robust job growth:

Silliness on Productivity, by Dean Baker: In discussing the December jobs report the Post repeated some of the silliness about productivity that is currently circulating among people who imagine themselves to be knowledgeable about the economy. It told readers that:

Employers slashed positions more dramatically in the past two years, squeezing more productivity out of remaining workers. That has led many analysts to expect a substantial increase in the number of jobs in the early months of 2010, as companies must hire again just to keep up with demand for their products.

Actually, productivity growth averaged 2.6 percent annually over the last two years. This is somewhat more rapid than the growth rate over the prior two years but it is below the 2.9 percent average annual growth rate in the decade from 1995 to 2005. In other words, there is nothing extraordinary about the recent rates of productivity growth so there is no special reason for believing that a burst of hiring is imminent.

In case you somehow missed it, I'd be happy to be wrong, but I am not anticipating a sudden burst of job growth anytime soon, and this worry is not new by any means.

This post has been republished from Mark Thoma's blog, Economist's View.

Underlying Economic Can Of Worms Will Hurt Investors In 2010

Matthew Buckley discusses how the economy's problems run deep despite the small signs of optimism on the surface. With every "green shoot" like growth in service jobs, there remains many fundamental issues that are yet to be resolved. See the following post from The Street.

One couldn't help but feel the optimism of the talking heads over the past couple of weeks as the espoused their rosy 2010 outlooks. Deep down I know that we're in for a Tiramisu Market.

My wife is not a big dessert person, but when she's offered tiramisu she always ends up ordering it, even if she initially demurs. Invariably, when the waiter walks away, she says, "I just like the top part." When the dessert arrives, she proceeds to eat the hard, sugary surface while bypassing the ... goo? ... that lies underneath.

Welcome to the 2010 market. The top may be good and pleasing for the short term, but underneath we have problems that no one wants to address and that are easier to push to the side of the table. Just give it back to the server.

Unemployment is hovering around 10%; growth is stagnant; housing is being propped up by, well, us; there's a wave of mortgage resets and foreclosures; there's a "new normal" in consumer spending (i.e., not a lot); the government printing press is smoking; and Congress is hell-bent on ramming through legislation that no one wants. Oh, and people are trying to kill us. All of us. And unfortunately they're eventually going to succeed, despite statements that "the system works."

I wish I could be more upbeat about the prospects for 2010, but after the party since March I'm feeling a little hungover ... and the bill just came. As first-quarter earnings season kicks off, the market will be looking past the cost-cutting efforts that boosted many bottom lines and looking for no kidding, old-fashioned profitability.

It's hard to be bearish. No one likes to be Eeyore. I'm long-term bullish -- I have to be. But I'm worried in the short term that the underlying issues will persist until we see job creation, housing stabilization, and restrained government spending. The government needs to halt the printing press; it's running out of ink.

We got to witness this Tiramisu effect in Dubai on Monday. The monstrosity formerly known as Burj Dubai was unveiled in a shower of fireworks and lights. The debut was interesting on several levels.

Dubai roiled the markets in December when it made the mistake of telling the world that it had spent more than it had. This apparently shocked investors, who believed their individual countries could never do such a thing.

Abu Dhabi decided that a foreclosure in its neighborhood wouldn't be good for home values, so it tossed a boatload of dirham to its neighbor. In a show of thanks, Sheik Mohammed renamed the Burj Dubai to honor his cousin (and new banker), Sheik Khalifa bin Zayed Al Nahyan.

It appears that the members of the United Arab Emirates recognize the value of a bailout. I wonder what would happen if U.S. businesses had such respect for folks that bailed them out.

"General Motors is honored to announce that we are renaming ourselves 'Government Motors' in honor of our vengeful but kind overlord."

"AIG(AIG Quote) is proud to announce that we have changed our name to 'America Issues Us a Gift' and thank the American people for their generous contributions. We needed that money to pay our bonuses."

In a throwback to a 1988 cult classic, Lloyd Blankfein says Goldman Sachs'(GS Quote) ticker will remain the same but going forward it will stand for "Got You, Suckers."

And lastly, Citigroup(C Quote) is renaming its headquarters at 399 Park Avenue "Paulson Place."

Firing Line: This market may look sweet on the outside, but underneath there's a mess. Although I think a little hair of the dog might help for a while, I definitely plan on skipping dessert.

This post has been republished from The Street.

Banks May Start Reducing Distressed Homeowner's Principal

The estimated 7 million foreclosures that are expected to hit in 2010 may force banks to reduce principal in a desperate attempt to keep homeowners paying their loans. Homeowners have little incentive to stay in their homes if they owe much more than their home is worth, but banks would have to declare huge losses if the masses walked away from their loans. See the following post from Expected Returns.

From Bloomberg, Principal Cuts on Lender Menus as Foreclosures Rise:

Efforts by U.S. banks to help distressed homeowners have focused mainly on temporary fixes such as interest-rate reductions that may only put off the day of reckoning, despite policy makers wanting them to do more.

Banks may be forced to resort to a remedy they’ve been trying to avoid -- principal reductions -- as another wave of foreclosures looms and payments on risky loans rise, Bloomberg BusinessWeek magazine reports in the Jan. 18 issue.

While interest-rate reductions or extending loan terms reduce homeowners’ monthly payments, they don’t give much comfort to borrowers who owe more on their homes than their properties are worth. Borrowers who don’t have equity in their homes are more likely to hand over the keys when they run into trouble. “The evidence is irrefutable,” Laurie Goodman, senior managing director of Amherst Securities Group in New York, testified before the U.S. House Financial Services Committee on Dec. 8. “Negative equity is the most important predictor of default.”

Banks are reaching maximum levels of desperation, perhaps because they know 2010 will be the year of the foreclosure. Please revisit last month's Wall Street Journal article, one in four borrowers is underwater, to get a sense of the severity of the housing crisis. As long as the labor market remains weak, housing will not recover meaningfully.

Also take a look at this article in today's Wall Street Journal, which explains that apartment vacancy rates are at 30-year highs. When rents go down, housing prices go down with it. This readjustment process in price to rent ratios will take some time to work itself through.
Extend and Pretend

The foreclosure crisis is likely to deepen this year in part because payments on many adjustable-rate mortgages are set to balloon. Unless there’s a sharp recovery in property values or a change in lenders’ willingness to cut principal, at least 7 million borrowers currently behind on their payments will lose their homes, Goodman estimates.

Some lenders may be coming around to the idea of principal reduction. “If you can right-size the mortgage and return to an equity situation, the incentive is to stay,” says Micah Green, an attorney at Patton Boggs in Washington and a lobbyist for a coalition of mortgage bond investors. Banks can either forgive principal outright or defer it. In deferrals the borrower must pay back the full amount on the original mortgage when he sells the property; if the ultimate sales price doesn’t cover the principal, the homeowner has to pay the difference, making it a less effective tool.

Our banking system has degenerated to the point where banks defer losses through the process of "extend and pretend". Primarily in the commercial real estate complex, banks are extending loan maturities in the desperate attempt to recoup their loaned money. The logic here is that by extending loans, banks can avoid massive writedowns in non-performing assets. This, of course, assumes that real estate prices will magically recover to bubble valuations. Absent a miraculous housing recovery, banks are sitting on huge losses.

The next wave down in housing will come as a surprise to most, even though the warning signs are flashing everywhere. We are in the middle of a secular downtrend in housing that will drag down our economy for years to come. I expect confidence to trough once again in 2010 as the economic recovery is proven to be an illusion. I believe this crisis in confidence will be centered around our banking system, which will be very supportive of gold prices.

This post has been republished from Moses Kim's blog, Expected Returns.

Why The Dollar Won't Crash In The Near Future

Steve Sjuggerud from Daily Wealth explains that the risk of the dollar value crashing is prevented by Asian countries who artificially prop up the dollar by buying US Treasuries. China's holdings of US Treasury bonds have increased by nearly ten-fold in the past decade and China must continue buying US Treasury bonds in order to maintain jobs creating cheap exports. See the following post from Daily Wealth.

Nine politicians in China control the fate of the United States of America.

I'm not kidding. The implications are scary. Let me explain...

These nine men are the Standing Committee of the Communist Party of China. They control the value of China's currency.

Fortunately, it's easy to forecast what a politician will do... He will do whatever it takes to keep his job.

The story is remarkably simple...

In China, the goal of these nine politicians is to keep the Communist Party in power. The way to accomplish that goal is for the masses to stay employed. Right now, China keeps the people working by exporting cheap goods. In order to make sure those Chinese goods stay cheap, the Standing Committee sets the currency exchange rate artificially low. And that is the crucial part of the story...

How do these nine politicians keep the exchange rate low? They buy U.S. dollars. Importantly, these nine men don't just sit on stacks of dollar bills... They invest those dollars in U.S. Treasury bonds.

It's gotten out of hand. China owns nearly $1 trillion worth of U.S. debt. China's holdings have increased dramatically every year... They've grown nearly tenfold since the end of 2000:

China Treasury Bond Holdings

2000 - $99 billion
2001 - $127 billion
2002 - $166 billion
2003 - $209 billion
2004 - $267 billion
2005 - $350 billion
2006 - $451 billion
2007 - $529 billion
2008 - $804 billion
2009 - $941 billion
*includes Hong Kong

And China's soon-to-be trillion dollars of U.S. government debt is not the end of the story. It's the beginning...

In order for other Asian countries to compete with China, they have to artificially keep their own exchange rates low. And that's exactly what they're doing. They're doing it the same way China does... They're buying mountains of U.S. Treasury bonds, too.

At this point, foreigners now own half of the U.S. Treasuries outstanding (of the ones that are not held by the U.S. government). And they're buying more... Most importantly, there's enough demand for U.S. debt from foreigners that the U.S. government can finance its deficits for years to come... all by simply selling Treasury bonds to foreigners.

Would you lend money to the U.S. government at 3.5% interest for 10 years? I sure wouldn't. I really can't name anyone who thinks 3.5% in government bonds is a good deal. The foreigners aren't buying to earn 3.5% interest. They're buying to keep the value of their currencies down.

India is an interesting example... Earlier this year, when India spent $6.7 billion buying gold from the IMF, it was all over the news. What WASN'T reported was that India bought far more U.S. Treasury bonds than gold. India has increased its stake in Treasuries by over $22 billion since last summer – increasing its Treasury bond holdings more than 200%.

So, yes, there's a mountain of demand for U.S. dollars – Treasury bonds – from all over the developing world. The important thing is demand will last. It will last as long as the nine men on China's Standing Committee don't change their minds.

So what does all this mean?

It means the U.S. dollar will not crash right now.

Most investors believe the U.S. dollar is about to crash. But the facts are clear... The dollar has ready buyers of hundreds of billions of dollars worth of Treasuries. While the dollar might lose ground against gold, the reality is, no other paper currency has a tailwind of hundreds of billions of dollars of buying waiting in the wings like the U.S. dollar does.

Eventually, the dollar bears will be right. The U.S. will have to face all its debt one day. But that story is not in my True Wealth Script for 2010.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

The Future Costs Of The Economic Bailout

It may be a generation before we know whether the government's massive spending was the right move, as the future costs of the debt remains uncertain. A new research paper by professors Carmen Reinhart and Kenneth Rogoff examines some of the potential effects to the future economy. See the following post from The Capital Spectator.

The monetary and fiscal stimulus dispensed by governments around the world was arguably effective in containing a recession and staving off depression. But if so, the question becomes: At what price?

Nothing is free in economics and so the world must grapple with the mountain of debt that now weighs on the global economy. In effect, policy makers have traded the acute for the chronic. Was it a worthwhile tradeoff? Perhaps, although the true answer won't be known for some time, perhaps as long as a generation.

Meanwhile, no one should underestimate the potential risks. A new research paper by professors Carmen Reinhart (University of Maryland) and Kenneth Rogoff (Harvard) bluntly lays out the stakes and the hazards that may be lurking. A working version of "Growth in a Time of Debt," forthcoming in American Economic Review, makes three key points. Quoting the paper, the authors advise:

• The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.

• Emerging markets face lower thresholds for external debt (public and private)—which is usually denominated in a foreign currency. When external debt reaches 60 percent of GDP, annual growth declines by about two percent; for higher levels, growth rates are roughly cut in half.

• There is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the United States, have experienced higher inflation when debt/GDP is high.) The story is entirely different for emerging markets, where inflation rises sharply as debt increases.

Reinhart and Rogoff's recently published book—This Time Is Different: Eight Centuries of Financial Folly, which we reviewed here—made a timely statement with its arrival last year and this academic pair continues the tradition with their latest work. As their paper notes, the U.S. is among the nations with the biggest percentage increase in debt since 2007. A recent estimate of U.S. debt-to-GDP ratio is 84%, according to Reinhart and Rogoff--dangerously close to the 90% threshold, as illustrated in the following chart taken from the paper.

The bottom line: Bailouts are expensive, perhaps more expensive than generally realized. The worst of the financial crisis and Great Recession may be over, and perhaps that's due partly to the intervention of central banks and governments around the world. (The business cycle was a factor too.) But let's not celebrate just yet. The cleanup era has only just begun and it's not yet clear how much it's going to cost.

This post has been republished from James Picerno's blog, The Capital Spectator.

Bernanke Deflects Blame For Financial Crisis

Bernanke's denial that monetary policy was a main factor leading up to the financial collapse may prevent the Fed from learning from past mistakes says James Picerno from The Capital Spectator. The real Fed funds rate was negative for roughly three years leading up to the financial collapse, suggesting that monetary policy was aggressively stimulative. See the following post from The Capital Spectator.

Fed Chairman Ben Bernanke says the central bank's monetary policy played no role laying the groundwork for 2008's financial debacle. The issue here is one of debating if interest rates were too low for too long and if that was a catalyst for sending the real estate market into overdrive.

"Monetary policy during that period [2002-2006] -- though certainly accommodative -- does not appear to have been inappropriate, given the state of the economy and policymakers' medium-term objectives," he said at a speech today in Atlanta at the American Economic Association, CNNMoney reports. The culprit, Bernanke added, was ill-conceived mortgages that made buying homes too easy.

The Fed head is half right. It's hard to imagine that the real estate boom would have been as strong as it was if interest rates weren't as low as they were in 2002-2006. Consider our graph below, which shows the effective Fed funds rate less the annual change in inflation, as defined by the consumer price index.



It's obvious that for a roughly three-year period starting in late-2005, the real Fed funds rate was negative, which is to say that monetary policy was aggressively stimulative. The case for keeping rates low was compelling in the wake of the 2000-2002 stock market correction and the mild 2001 recession. But the central bank misjudged what the economy needed at the time. That's clear now, with the benefit of hindsight, as a number monetary economists advise.

For example, Anna Schwartz, an economist at the NBER, recently opined that "the Fed was accommodative too long from 2001 on and was slow to tighten monetary policy, delaying tightening until June 2004 and then ending the monthly 25 basis point increase in August 2006."

We can argue if central bankers should have made better policy decisions in real time. In a world of fiat money, mistakes are inevitable when mere mortals are at the monetary helm, as we discussed recently. That's the price of doing business in central banking as it's currently practiced. What's troubling is arguing that the Fed played no role in stoking the fires of the former real estate bubble. Policy is never going to be perfect, but the degree of error in 2002-2006 now looks extraordinary. Yes, hindsight is 20-20, and so we should be careful here in arguing that another crew might have done things differently. But if we can't at least recognize an error, the odds of learning from past mistakes look virtually nil.

The question is less about blame and more of figuring out how to improve monetary policy going forward. Indeed, the stakes are higher than ever for the years ahead.

Progress comes slowly in economics and finance. It's even slower with a brick of denial tied to your legs.

This post has been republished from James Picerno's blog, The Capital Spectator.

The Economic Consequences Of Unfair Trade Practices

Peter Morici argues that China's currency manipulation and unfair trade practices are cutting away hundreds of billions from US GDP. It may be impossible to restore jobs to pre-recession levels unless the US addresses trade issues with China. See the following post from The Street.

No economic policy could better serve Americans than genuine free trade. But open trade policies are failing Americans.

Free trade is a compelling idea: Let each nation do more of what it does best and specialization will raise productivity and incomes.

Americans aren't sharing in those benefits because President Obama, like President Bush, permits China and others to cheat on the rules, unchallenged, to the detriment of the U.S. interests he was elected to champion.

The World Trade Organization has greatly reduced tariffs, prohibits virtually all export subsidies, and regulates other national policies that could subvert trade, such as health and product safety standards arbitrarily slanted to favor domestic suppliers.

For these rules to optimize trade, raise productivity and boost incomes, exchange rates must adjust to reasonably reflect production costs. To buy Chinese televisions, Americans must be able to purchase yuan with dollars; however, an artificially strong dollar that overprices U.S. tractors and software in China will unravel the benefits of trade by denying Americans opportunities to export to pay for those televisions.

Exchange rates are established in currency markets, created by businesses trading through major financial institutions. Unfortunately, China and several other Asian governments blatantly manipulate those markets without a credible U.S. response and with ruinous consequences for American workers.

The United States annually exports $1.6 trillion in goods and services, and these finance a like amount of imports. This raises U.S. gross domestic product by about $170 billion, because workers are about 10% more productive in export industries, such as software, than in import-competing industries, such as apparel.

Unfortunately, U.S. imports exceed exports by another $400 billion, and workers released from making those products go into non-trade-competing industries, such as retailing, in which productivity is at least 50% lower. This slashes gross domestic product by about $200 billion, overwhelming the gains from trade, and requires workers displaced by imports to accept lower wages.

The trade deficit creates an excess supply of dollars in international currency markets, as Americans offer more dollars to purchase foreign products than foreigners demand to purchase U.S. products.

Simple supply and demand should drive down the value of the dollar against the yuan and other currencies, make U.S. imports more expensive and exports cheaper, and reduce or eliminate the trade deficit. But the Chinese government subverts this process by habitually printing and selling yuan for dollars in currency markets, keeping its currency and exports artificially cheap.

Currency manipulation creates a 25% subsidy on China's exports, and other Asian countries are impelled to follow similar policies, lest their exports lose competitiveness to Chinese products.

Also, huge trade imbalances between Asia and the West, perpetuated by currency mercantilism, create an imbalance in demand -- a shortage of demand for the goods and services produced in the United States and Europe, and artificially robust demand for products made in China and elsewhere in Asia.

Consequently, to keep the U.S. economy going, Americans must both borrow from foreigners and spend too much, as they did through 2008, or their government must amass huge budget deficits by borrowing from abroad, as it is now does thanks to stimulus spending and the Troubled Asset Relief Program.

In the bargain, the United States sends manufacturing jobs to Asia in industries that would be competitive, but for rigged exchange rates. The trade deficit slices $400 billion to $600 billion off GDP, and Americans suffer unemployment above 10%.

China grows at nearly 10% a year and makes American diplomats look like fools for advocating free markets as a growth policy.

Campaigning for the presidency, Barack Obama promised to do something about Chinese currency manipulation. Instead, like a good supplicant, he now thanks Chinese officials for buying U.S. Treasury securities.

China's development policies make its leaders look smart but nothing makes them look like geniuses better than an American president who appeases their beggar-thy-neighbor policies.

It will be impossible for the United States to create the 9 million jobs needed to bring unemployment down to pre-recession levels without taking on China's currency manipulation and other unfair trade practices.

For that Americans may need to wait for a better president, one with the courage to stand up to China.

This post has been republished from The Street.

A Decade That Paved The Way To Economic Hell

Peter Schiff discusses why the real cost of the past decade will have to be paid in the future and our economic problems will continue to pile up if people and governments don't stop spending more than they earn. Last decade's huge party of overindulgence is sure to lead to a massive hangover in this decade. See the following post from The Street.

In its recent look back on the first 10 years of the century, Time Magazine proclaimed the period to be "the decade from hell." The editors made their case based on what they saw as the signature events of the last ten years, notably the ravages of terrorism, failed wars, and a global financial crisis. Taken together, these factors produced an era that Time is convinced will be remembered as one of the low points in our history.

As the media hates to dwell on the negative, the commentary was rife with notes of optimism about pending recovery. It could hardly be accidental that in the very next issue, Fed Chairman Ben Bernanke was named "Man of the Year" for his supposedly Herculean efforts to keep the economy afloat as we departed the Naughty Aughties. Although Time takes pains that to point out that the "Person of the Year" honor reflects impact rather than adulation, its profile of the Chairman was triumphant.

Even if you believe the "survived the worst/turned the corner" narrative offered by Time, it still should strike anyone as ironic that Chairman Bernanke, a chief architect of the economic problems that surfaced in 2007, should be held in such high esteem.

Apart from its misplaced reverence for the Fed Chairman, I would take issue with Time's entire characterization of what has now become history.

Under no circumstances could the past ten years be described as "the decade from hell." In fact, in terms of economic good fortune, the period shares parallels with the Roaring Twenties. I would describe this as a decade of sin that paved the way to hell.

Yes, we had spectacular problems like September 11th and the invasion of Iraq - which were horrific for those who were directly affected - but for most Americans, it was a time of unexpected wealth and unearned prosperity. Up to the days of the stock market crash, the economics of the decade will be remembered for cash-out refinancing for millions of homeowners, no-doc liar loans, no-money-down car purchases, eight-figure Wall Street bonuses, cheap Chinese imports, and trample-to-death holiday sales. In other words, the decade now closing gave us the biggest and most irresponsible spending orgy in U.S. history. The past decade was the party; the one ahead will be the hangover.

The fact that Time completely ignored these issues shows how poorly the mainstream media understands the forces bearing down on our economy. Yes, they were able to identify some of the adverse consequences we experienced this decade. That's the easy part. But as far as seeing the causes behind the effects, they haven't a clue. As a result, Time has no ability to see the underlying pattern and will happily encourage our leaders to repeat the mistakes of the past on a grander scale.

For now, Congress and the President remain as clueless as Time. To show its resolve to 'get to the bottom of things,' the Obama Administration has impaneled a commission to investigate the causes of the financial crisis. Do not expect the proceedings, which are just getting underway, to come up with anything but the most politically useful explanations.

Blame will be laid at the feet of 'ineffective regulators' who failed to 'get tough' with industry, banks, and corporate leaders who held the 'public good' hostage to their 'personal greed.' There is no hope that anyone who actually saw the crisis coming will actually be asked to testify. If they called me, I would be happy to give them an earful. Unfortunately, the only way my views will ever be heard by the powers-that-be is if I am elected to the Senate - which is exactly what I plan to do next fall in my home state of Connecticut.

My sincere hope for the coming decade is that I can help our leaders see what Time cannot: we need to stop committing the economic sins that are leading us to hell, so that our stay down there will be as brief as possible. We need everyone to stop spending more than they earn. That is true not just for individuals, but for our government as well. Just this week, the Treasury Department removed its internal caps on bailout funds to Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote). Meanwhile, another bailout was proffered to ailing GMAC. If we continue the same bad behavior, it might not just be one decade from hell, but several.

However, if we can confess our sins, and vow to reform our ways, perhaps this will merely be a decade in purgatory. Perhaps we can turn it into the decade of hope, hard work, individual liberty, savings, production, investment, sound money, de-regulation, exports, budget surpluses, capitalism, limited government, and respect for the Constitution. These traits will harden us to withstand the fallout from our reckless past.

As of yet, our troubles continue to snowball - and I don't like a snowball's chances if we have a real decade from hell.

This post has been republished from The Street.

Can The Government Avoid A Repeat Of The 1937 Mistake

Paul Krugman is worried about a repeat of 1937 when the government made the mistake of removing the economic stimulus too quickly, causing a double-dip recession. Tim Iacono points out that 1937 was preceded by three years of strong economic growth, which is not the case today. See the following from The Mess That Greenspan Made.

In his most recent commentary at the New York Times, Nobel Prize winning economist and Sunday talk show curmudgeon Paul Krugman says that we're about to make the same mistakes that were made 73 years ago, five years after the depths of the Great Depression, when the entire nation was sure that the worst was behind it.

That 1937 Feeling
Here’s what’s coming in economic news: The next employment report could show the economy adding jobs for the first time in two years. The next G.D.P. report is likely to show solid growth in late 2009. There will be lots of bullish commentary — and the calls we’re already hearing for an end to stimulus, for reversing the steps the government and the Federal Reserve took to prop up the economy, will grow even louder.

But if those calls are heeded, we’ll be repeating the great mistake of 1937, when the Fed and the Roosevelt administration decided that the Great Depression was over, that it was time for the economy to throw away its crutches. Spending was cut back, monetary policy was tightened — and the economy promptly plunged back into the depths.

This shouldn’t be happening. Both Ben Bernanke, the Fed chairman, and Christina Romer, who heads President Obama’s Council of Economic Advisers, are scholars of the Great Depression. Ms. Romer has warned explicitly against re-enacting the events of 1937. But those who remember the past sometimes repeat it anyway.

Yes, there are some similarities between economic conditions today and in 1937, but GDP isn't one of them, a point that is demonstrated quite clearly in the chart below.

By 1937, the nation had experienced three full years of rip-roaring economic growth and was well into its fourth. You can kind of understand why they may have thought that the worst was over, even though unemployment remained high.



While the argument that, today, an early end to the stimulus could send the nation's economy back into a recession (or worse) is well founded, the comparison to 1937 is being far too generous to the current state of affairs in the U.S.

What Krugman should have said was, "Look, all we've done over the last year or two with the massive government stimulus programs and money printing, the likes of which the planet has never seen before, is to delay the arrival of 1932. If you want 1932 to occur in 2010, then go ahead and withdrawal the stimulus".

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Credit Card Regulation Could Shift Consumer Attitudes

Credit card companies will have to come up with creative ways to recoup some of the estimated $20 to 50 billion in revenue they are expected to lose as a result of the Credit Card Accountability Responsibility and Disclosure Act of 2009, and some tactics may be enough to cause a consumer revolt. A Wall Street Journal story described offers sent out by South Dakota-based First Premier Bank which disclosed an interest rate of 79.9%. The disclosure of outrageous interest rates could help bring about a shift in consumer's "buy now, pay later" approach to personal finance that has fueled the economy for decades. See the following article from The Mess That Greenspan Made for more on this.

Not knowing or caring what my credit card interest rates or terms have been for many years now, having paid the accumulated balance in full on a monthly basis save for one instance when an honest mistake delayed payment and both the interest charge and late fee were reversed after a pleasant phone call to the number on the back of the card (is that even possible these days?), I can only imagine what others will be going through in the new year.

Apparently, banks are now racing to levy new fees and hike interest rates where they can in order to make up for revenue that will soon be lost when the new credit card law goes into effect next month.

Reports indicate that somewhere between about $20 billion and $50 billion in lost banking revenue will soon have to be replaced as a result of the Credit Card Accountability Responsibility and Disclosure Act of 2009 and, unfortunately for the American consumer, when it comes to fees, banks can be very creative - annual fees, processing fees, statement fees, and all sorts of other fees that they probably haven't even dreamed up yet.

Probably the most outrageous example of the impact that the new bill has had on charge card terms comes via this WSJ story that you have to read a couple of times before realizing that there are no typographical errors involved.

Clearly, we are now entering a new world of even more bizarre (and mostly larger) numbers when it comes to credit cards, all of which will serve to heighten the general dissatisfaction that U.S. consumers have with banks, if not with their elected officials.

Mandatory Usury in One Lesson
How Congress dictated a 79.9% interest rate.

'You might have less-than-perfect credit and we're OK with that," read an October credit-card solicitation from South Dakota-based First Premier Bank. The interest rate, however, will strike some as usurious: 79.9%. That's a more than eightfold increase from the 9.9% the bank previously collected for a similar card.

Wait, wasn't Congress supposed to have passed legislation against predatory lending? As a matter of fact, yes. The whopping rate increase is First Premier's way of complying with the Credit Card Accountability, Responsibility and Disclosure Act of 2009. Among other provisions, that law prohibits fees of more than 25% above a card's credit limit. First Premier has been offering an account with a $250 limit and annual fees of $256. By law the latter figure must come down to $75. To compensate for the lost $181 in fees, the bank is raising the rate by 70% of $250, or $175, a year.

Already, there is talk of Credit Card Tea Parties that will likely add more unpleasant political overtones to what is already a contentious debate about the role of big banks in the U.S. during an election year.

But, more than anything else, this will probably only accelerate the pace at which Americans in general shun the "buy now, pay later" approach to their finances that has helped sustain the national economy for decades.

Of course, Washington D.C.'s "buy now, pay never" approach may someday come under attack, but probably not for a little while.

The manner in which banks make up these lost billions in fees may give "the new frugality" a shot in the arm this year. If nothing else, it will surely be entertaining to see how creative banks can be when it comes to replacing lost credit card revenue.

This article has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Bernanke Willing To Use Monetary Policy To Fight Asset Bubbles

Ben Bernanke says that monetary policy was not a primary cause of the housing bubble but is ready to consider raising interest rates to fight future bubbles if regulation fails. Mark Thomas calls this an evolution from Alan Greenspan's philosophy in which he argued that the Fed could not identify bubbles as they were inflating with sufficient clarity and believed that raising interest rates was just as likely to cause harm. See the following post from Economist's View for more on this.

Ben Bernanke says Federal Reserve interest rate policy after the dot.com bubble burst did not cause the housing bubble, and he delivers a strong rebuttal to John Taylor on that point. He argues the problem was with the regulation of these markets, not the low interest rates after the dot.com crash, and based upon this reading of the causes of the crisis, he believes regulation is the key to preventing bubbles. But he also acknowledges that if regulation fails to get the job done, then the Fed must step in and pop bubbles before they get too large by raising interest rates (though doubts are expressed about whether increasing interest rates would have done much to stop the bubble, hence the strong preference for regulatory solutions).

This is a big step forward relative to the Greenspan years. Greenspan argued that the Fed could not identify bubbles as they are inflating with sufficient clarity to allow policy to do much about them, he thought the Fed was as likely to do harm from raising interest rates based upon false bubble alarms as it was to prevent problems. And in any case, he believed that cleaning up after bubbles popped would be enough to avoid large downturns like we are experiencing. The best that the Fed could do given the difficulty in identifying bubbles ex-ante is to clean up after they self-identify by popping, but that would be more than enough to keep the economy from experiencing big crashes.

Greenspan's view that cleaning up ex-post would be sufficient to insulate the economy from large shocks turned out to be incorrect. He also resisted and actively dismissed regulatory interventions intended to keep the financial sector stable and keep bubbles from inflating in the first place, and this, too, was a mistake. In the past, Bernanke and other members of the Fed have also been resistant to using interest rate policy (as opposed to regulation) to prevent bubbles, so this is an evolution in the Fed's view of its role in preventing asset price bubbles from threatening the stability of the broader economy.

The Fed still strongly prefers regulatory solutions, the main problem with interest solutions are that bubbles are hard to identify, and even if you do identify them, interest rate increases affect all industries, not just the one experiencing the bubble, so the policy inflicts collateral damage (though perhaps less collateral damage than if the bubble actually pops). In this regard, I wish Bernanke would have talked about how the Fed might find better measures of growing financial market imbalances, measures that would allow it to better identify bubbles a priori. We can use interest rate and regulatory policy to fight bubbles much better and target policy more precisely if we have more certainty about the existence of bubbles as they are inflating, but that will require the Fed to develop much better measures of financial market fragility than it now has. (This is an alternative to incorporating asset prices into the index the Fed targets through its implicit Taylor rule, something that automatically raises interest rates when asset prices increase substantially and something that I've advocated in the past. Incorporating asset prices into the inflation index the Fed stabilizes is a very broad-brushed approach to the problem of fighting bubbles, so more targeted approaches are preferable). I realize that we have models saying it isn't possible to identify bubbles as they are inflating, but models aren't reality - they aren't always correct - and we won't really know until we try:

Monetary Policy and the Housing Bubble, Ben S. Bernanke, Chair, FRB: The financial crisis that began in August 2007 has been the most severe of the post-World War II era and, very possibly--once one takes into account the global scope of the crisis, its broad effects on a range of markets and institutions, and the number of systemically critical financial institutions that failed or came close to failure--the worst in modern history. Although forceful responses by policymakers around the world avoided an utter collapse of the global financial system in the fall of 2008, the crisis was nevertheless sufficiently intense to spark a deep global recession from which we are only now beginning to recover.

Even as we continue working to stabilize our financial system and reinvigorate our economy, it is essential that we learn the lessons of the crisis so that we can prevent it from happening again. Because the crisis was so complex, its lessons are many, and they are not always straightforward. Surely, both the private sector and financial regulators must improve their ability to monitor and control risk-taking. The crisis revealed not only weaknesses in regulators' oversight of financial institutions, but also, more fundamentally, important gaps in the architecture of financial regulation around the world. For our part, the Federal Reserve has been working hard to identify problems and to improve and strengthen our supervisory policies and practices, and we have advocated substantial legislative and regulatory reforms to address problems exposed by the crisis.

As with regulatory policy, we must discern the lessons of the crisis for monetary policy. However, the nature of those lessons is controversial. Some observers have assigned monetary policy a central role in the crisis. Specifically, they claim that excessively easy monetary policy by the Federal Reserve in the first half of the decade helped cause a bubble in house prices in the United States, a bubble whose inevitable collapse proved a major source of the financial and economic stresses of the past two years. Proponents of this view typically argue for a substantially greater role for monetary policy in preventing and controlling bubbles in the prices of housing and other assets. In contrast, others have taken the position that policy was appropriate for the macroeconomic conditions that prevailed, and that it was neither a principal cause of the housing bubble nor the right tool for controlling the increase in house prices. Obviously, in light of the economic damage inflicted by the collapses of two asset price bubbles over the past decade, a great deal more than historical accuracy rides on the resolution of this debate.

The goal of my remarks today is to shed some light on these questions. I will first review U.S. monetary policy in the aftermath of the 2001 recession and assess whether the policy was appropriate, given the state of the economy at that time and the information that was available to policymakers. I will then discuss some evidence on the sources of the U.S. housing bubble, including the role of monetary policy. Finally, I will draw some lessons for future monetary and regulatory policies.1

You can view the full speech at the Federal Reserve site.

This post has been republished from Mark Thoma's blog, Economist's View.

Is The Homebuyer Tax Credit Too Small?

Tim Iacono from The Mess That Greenspan Made points out that the homebuyer tax credit is relatively small compared to the average price of homes and is not even keeping up with home inflation. He argues that if the government wants to increase home prices (say to increase property tax revenues), they will have to significantly increase the tax credit.

The $8,000 homebuyer tax credit in relation to the average sales price for existing homes over the summer of about $220,000 (per the National Association of Realtors) is:

3.6%

The percentage that home prices have risen from May to October (per the seasonally adjusted S&P Case-Shiller 20-City Home Price Index) is:

3.4%

Obviously there are other ways to look at this. For example, relative to the median sales price for existing homes of about $175,000, the $8,000 tax credit is 4.6 percent, more than a full percentage point greater than the increase in seasonally adjusted home prices. Or, using unadjusted Case-Shiller data, home prices have increased 5.3 percent since the spring, greater than either tax credit percentage.

Whatever figures you use, the tax credit and the home price gains are pretty close.

There is clear message here for the U.S. government. If they really want home prices to go back up, they need to drastically increase the tax credit. Maybe they should double it to about $15,000 next summer and then move it up to $25,000 or so in 2011, increasing the tax credit regularly as needed to keep home prices rising.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.