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The UK produced more than its fair share of economic headlines this week. Interest rates were kept on hold at the historical low of 0.5%, as expected. Not one commentator predicted a rise prior to the announcement and there was a similar paucity of predictions suggesting the Bank of England Monetary Policy Committee would cut rates further. The BoE did take the opportunity though to ambush markets with a surprise statement regarding its quantitative easing program. The £125bn originally agreed is almost fully utilised, with only £15bn of the budget remaining. The BoE have decided to pause the program when the £125bn initial budget is fully utilised.
Markets were broadly expecting an expansion of the policy. UK Gilt prices fell sharply in response, with yields spiking, as investors reduced exposure to the asset class on realisation a major buyer of bonds would imminently retire from the Gilt market, at least temporarily. The BoE advised it was keen to digest the economic and inflationary impact of the easing to date before possibly injecting further cash into the economic system. Following the announcement a number of analysts speculated the BoE had seen enough improvement in economic data to persuade them further action might provoke inflation and that the BoE, despite their cautious sound-bites, were confident the economy is already returning to growth.
Preliminary Q2 GDP data is due shortly, followed by a Q2 inflation report in August. Following those announcements, the BoE is likely to hold sufficient data to cement a decision, one way or the other, regarding the need for further stimulus.
The S&P 500 suffered a sharp bout of profit taking on Monday ahead of the 2-day Fed meeting. No rate change is expected but Wedndesday’s speech could move markets significantly as investors continue to fret over both the strength of the economic recovery and rising inflationary pressures. The S&P 500 fell through the key 900 support level so further losses are possible if Bernanke fails to reassure.
Heatmap Source: http://www.finviz.com
S&P 500 22nd June 2009 Suffers Red Day
Imagine for just a few moments an economy with no debt. You have no ability to borrow or lend, nor does any other participant in the economy. There is also no mechanism to print money and therefore to create additional nominal paper wealth. The only assets you own were purchased with the fruits of your labour and enterprise. The only money you have is from the proceeds of assets you previously sold or income from labour and enterprise, yet unspent. Also in this fictional land, the nominal supply of money, coins and bank notes, exactly equals the true nominal and economic value of society’s wealth, This wealth consists of ready to use commodities (grown coffee, mined coal, etc) and real, not paper, assets. If the rate of saving increases, or the holding period between transactions lengthens, the velocity of money and real economic activity decreases. If through natural disaster or war, assets are destroyed, the nominal value of paper money would be greater than the economic value of real assets. In this environment of fixed money supply with no ability to lend, borrow or print money, society can only theoretically accumulate more assets in future periods, than it did in the past, by improving the efficiency of commodity growth and extraction or by inventing new products of economic value. But unless money supply is increased, or the circulation of money accelerates, the prices of assets and commodities would have to fall, due to the increased supply of commodities and assets relative to fixed paper money supply. Furthermore, you could not increase your personal real economic wealth by working longer hours unless another participant was willing to work less hours as your increased output would also create excess supply that the fixed monetary base could only purchase through deflation of asset prices.
Let’s build into this zero sum economic model, debt, the ability to lend and borrow. Again money supply is unchanged. The zero sum game is also unchanged. The flow of money is altered but no real economic growth is secured. The only change is the timing of consumption for each party. The borrower enjoys higher consumption now at the expense of future consumption. He is spending future income. The lender forsakes current consumption, preferring to consume later when the debt is repaid. The real economic asset base is unchanged. The borrower can purchase assets, employ more staff, pay higher wages but if the supply of money is unchanged every extra dollar he spends is directly offset by the decrease in economic activity of the lender.
So debt by itself, within a fixed money supply economy, is a financial transaction that creates no real economic growth. Progressing towards a more realistic scenario, closer to today’s economy let us introduce the concept of new and additional money supply. Not new economic wealth, just new paper money. The creator of this paper is seeking to stimulate the economy and decides to allocate a third each to Consumption, Lending and Investment. (By investment I am referring to the creation of new assets of economic value and the improvement of existing production efficiencies, not the purchase of assets already in circulation). Examining each of the three in isolation, if new money is added to an economy within a fixed asset base, purely to increase consumption, inflation is caused as demand increases whilst supply is constant. Nothing new of economic value has been created. Each unit of paper money is just worth less relative to the unchanged real economic asset base. Borrowing to purely consume creates inflation and has zero sustained economic benefits.
The second scenario relates to the share of printed money that is lent and borrowed. If the borrower uses his additional paper money to consume the economic impact is unchanged, as above. If the paper money is used to buy completed assets, again as discussed above, the only occurrence will be inflation in the price of assets. Debt used to increase consumption or purchase assets has zero sustained economic benefit, only the flow of money changes. There is no new real economic wealth, just inflation, or asset price bubbles, or both.
Therefore, only newly printed money that is invested into the process of building new assets of economic value has a positive impact on growth. Increases in consumption can only be sustained if it is the function of an enlarged asset base of economic value exactly matched by an increase in the supply of nominal paper wealth.
To achieve real economic growth, society must have a mechanism that increases money supply which both facilitates and mirrors real economic growth, (the increase in quantity of real assets). In the absence of this scenario when newly printed money is allocated to the purchase of completed assets, or consumption, rather than applied to investment in the production of new assets or invested to improve current output efficiencies, zero real economic growth occurs and asset price bubbles are created.
Applying this theory to the current stimulus policy and the new paper money printed by the Fed and other monetary authorities, every dollar spent on supporting consumption or used in the purchase of completed assets has zero true economic value and is today’s generation borrowing from the income of future generations. It’s fake growth, here-today-gone-tomorrow paper wealth. Therefore every dollar allocated to the balance sheets of failed banks, which is then lent to stimulate consumption or used in the acquisition of existing in-circulation assets represent transactions of no true economic value. Supporting financial institutions that profit from building fake wealth probably isn’t a great idea either.
In fact the stimulus package is quite successfully re-building the same myth of debt-fuelled economic growth and is deepening the embedded structural problems of a debt based society, which incorrectly allocates printed money to consumption and zero-sum financial transactions rather than into real economic investment.
If you persist with the same course of action, is it reasonable to expect a different outcome?
Government sourced inflation data is often close to worthless. For example the basket of goods they use here, in the UK, includes items that the average family can’t afford in a recession. The real basket of goods for lower-middle and working class families is much more exposed to food and energy costs than the official government basket suggests. It doesn’t matter if iPods, DVDs, vacations and new cars are falling in price when food, oil, electricity, etc are rising (as they have for most of the past 2-3 years). Families can’t afford the former luxuries and have to buy the latter necessities. Add into the equation stalled personal earnings growth and in this recession you have a much higher real inflation rate for most people than the official government data suggests. Unfortunately the central bank and governmental bureaucrats can’t empathise with real people from their 2nd home in the Hamptons (or Tuscany for Euro-zone box-tickers).
I’ll give you another example of how out-of-touch the bureaucrats are in the UK. The government is giving a £2,000 cash grant for new car purchases if the buyer part-exchanges their old, less fuel efficient car. Well you still need to put down say £13,000 to secure the average new family car. So the middle class and wealthy who have £13,000 or more sloshing around their bank account get a nice discount to buy a car. If someone doesn’t have £13,000 spare to buy a new car, (and I humbly suggest consumers like that need the help more), you get nothing. It’s redistribution of tax-payers money from the poor to those rich enough to buy new cars. Madness.
“We’re In an Inflationary Recession That May Start to Accelerate” You almost got the headline right. It should read “We’re In an Inflationary Recovery That May Start to Accelerate”. There is a whole world out there outside of the US. In the UK for example the respected National Institute of Economic and Social Research predicts the UK economy experienced positive MoM GDP in April. China never even went into a recession. Commodity prices are rising strongly. Banks are back in profit. We have seen unprecedented monetary easing and government stimulus. Futures, last Friday, priced in a 59% chance of the Fed having to increase rates by November. Stagflation is not even on the agenda. http://www.tradinghelpdesk.com
The US looks increasingly primed to return to economic growth in 2009, before Europe. The more assertive action by the Federal Reserve via aggressive rate cuts, Fed balance sheet expansion, widespread government fiscal easing and banking sector intervention have all contributed to the consensus expectation of a Q3/Q4 recovery. Incredibly, so quickly are market-wide forecasts changing, the US futures market is now pricing in a 59% probability that interest rates will increase in Q4 2009. A month ago, such a suggestion would have been ridiculed by most analysts.
This about-turn, from deflationary to inflationary concerns, is not based on vague hope of a recovery in demand. Sharp price increases have already been seen in commodity markets. Expectations of monetary tightening, rather than additional injections of liquidity, were further supported on Friday following an unexpected improvement in non-farm payrolls data, discussed below, and confirmation Federal Reserve officials met last week to discuss potential timing of credit tightening measures to wean investors off the abnormally high levels of manufactured liquidity.
It’s worth looking at the non-farm payrolls data in more detail as it is one of the most keenly anticipated regular economic reports, with a proven ability to move markets significantly when the actual data differs greatly from the consensus, as it did this month. Interestingly, the numbers were still bad (payrolls fell by 345,000 in May), but not nearly as bad as the 500,000 to 520,000 reduction predicted by most analysts. Also released was the country-wide unemployment rate, which rose to 9.4% relative to an average forecast of 9.2%. Although, unlike the payrolls data this rate worsened more than expected, a number of market commentators interpreted this data with rose tinted glasses suggesting more long-term jobless who previously had no hope of finding work were now registering officially as job-seekers. On a corporate level both General Motors and American Express are expected to make further job cuts, whereas Wal-Mart (The owner of UK’s Asda), confirmed it was looking to recruit 22,000 more staff in line with its US store expansion plan. The US economy has now lost 6 million jobs since the start of the recession and the current unemployment rate is at a depressing 26 year high but the monthly rate of job losses looks likely to ease through the rest of 2009 relative to H1, before the US returns to employment growth sometime in 2010.
Naturally, in the face of such job uncertainty, US consumers have changed their spending habits. More Americans are saving. April saw the highest ratio of consumer saving to spending in 14 years. Consumer borrowing has also eased with April seeing the 2nd biggest fall in lending, since records began ($15.7bn lower). This return to relative prudence was and still is desperately required to fix the personal balance sheets of consumers who are burdened with too much debt and not enough savings.
The continuation of better than expected US economic data helped the dollar rally against the yen, euro and sterling, though there are domestic issues in Britain that also encouraged dollar appreciation against the pound. The Australian and New Zealand dollars also appreciated against most G7 currencies as investors chased yield, investing in currencies offering a higher return. The USD rally also reflects widening sentiment that the US will lead western economies out of the recession. Not surprisingly, the dithering European Central Bank is still paying catch-up and an ECB spokesman dropped hints on Friday that rates may have to fall further in the Euro-zone to stimulate growth.
Do we really want to go back to the sham economics of the past 10 – 30 years? Will be interesting to see what Ron Paul’s legislation bid turns up re auditing the Federal Reserve.
The UK economy is slowly recovering. The green shoots of consumer demand, stabilisation in house prices, a 3 month stock market rally, the banking sector back in profit and deals being agreed in a buoyant commodity sector are collectively more than adequate evidence. There is still much work to be done, but a return to growth is highly probable in the not too distant future. Ironically, some of the credit can be allocated to the same institutions and quasi-governmental bodies that got us into this debt fuelled mess in the first place, but nevertheless, there is now clear light at the end of the recessionary tunnel. Of course there is always a chance that the fragile recovery will fade and the recession will be prolonged, particularly if business and consumer confidence in UK PLC has a reason to retreat. So what is the biggest threat to growing confidence and a successful UK economic recovery? I believe the largest single threat is further political chaos. I would suggest our politicians should be in back-to-back meetings creating an environment in which the unemployed can get back into work. They should be working with the Bank of England to ensure the £125bn stimulus package is used as quickly and efficiently as possible. Or, equally important, cutting back on red-tape in an effort to reduce the country’s growing debt burden, predicted to be £175bn in this tax year alone. Unfortunately, such crucial objectives hardly got a mention this week. The country had to suffer politicians, the names of whom were largely unknown to us a month ago, whinging over their career prospects or smirking at cameras with “rocking the boat” badges in an appalling episode of self-indulgence and self promotion. The local election results, in which Labour received its lowest ever share of the vote, will produce further unbearable months of political back-stabbing and manoeuvring, probably all the way to the next general election. Meanwhile, Barack Obama was giving a free master-class in statesmanship, touring the Middle East and receiving standing ovations from Arab audiences on his vision for the region and the world. I can’t imagine Obama has been busy submitting dubious expense claims for a non-existent mortgage either.
I empathise with readers who feel economic and stock market reviews should minimise political banter but UK politics and economics have never been more closely aligned, except during the World Wars. Further evidence of the political impact on equities and currencies was seen this past week, when both the FTSE and Sterling, fell back sharply, albeit temporarily, on unfounded rumours that Gordon Brown had resigned. Politics is markets.
Other news included a hold on interest rates. The Bank of England monetary policy committee voted to keep rates at 0.50%. The decision was in line with expectations and analysts were more focused on possible policy changes to the additional stimulus package, which so far has allocated around £125bn of the £150bn budget for boosting economic growth and lending. A number of commentators quite rightly suggested that that impact has been less than forecasted and the remaining £25bn, yet unallocated, will need to be utilised over the summer months unless lending activity accelerates from the current sloth like rate of growth.
For some weeks now this weekly review has ‘called’ Q1 or Q2 2009 as the trough of the economic cycle. Initially there was much risk in the statement as the global and US recovery was by no means certain, but as the weeks have progressed the ongoing stream of economic data has increasingly supported this view. The consensus among market commentators has also moved towards our more optimistic pro-recovery stance and now a Q3/Q4 recovery is a mainstream prediction, rather than the hopeful rhetoric of the enlightened minority. Our view did of course fully consider the unusually bitter and sharp contraction in growth primarily caused by very poor leadership in the global banking sector, ineffective regulatory risk controls and appalling credit procedures in the mortgage and commercial lending market place. But whilst we accepted this scenario as depressingly and worryingly unique in modern times, with only the depression of the 1930’s having close similarities, we also reflected on the impact of the unprecedented wall of money flooding into the global economy via government and central bank stimulus packages and its effect on demand. The global economy has never enjoyed such internationally co-ordinated monetary easing or the simultaneous hard–cash injections by governments, to shore up the balance sheets of strategically important institutions. The consequences of this combined stimulus are already being seen in the price of commodities, including oil and gold. Looking beyond the current market-wide inflation data which does not yet fully reflect improving demand outside of the resource sector, we predict that deflation will not only fade from the vocabulary of pessimistic US economists, but that concerns over inflation will return with vengeance within 18 months. The real challenge for 2010 is not achieving stronger global economic growth, a scenario which looks inevitable relative to 2009, but how to restore stable economic growth without killing the US consumer spending recovery with sharp interest rate rises, the usual primitive remedy for rising inflation. We would stress this view is not implying the deep structural problems within capitalism are being fixed. A move away from a cyclical, debt based economic system would need to be implemented for that. Nor is it an equity market prediction, which is below. But we do think the US and global economy, in terms of Gross Domestic Product, is set for a significant improvement from its Q1/Q2 trough.
Looking at the most recent US economic news in more detail, revised data now indicates the US economy weakened less than initially estimated in Q1 contracting at a 5.7% annualised rate, rather than the 6.1% fall previously announced. Investor’s, prior to the announcement, had been even more optimistic and predicted on average, the figure to be revised to a 5.5% contraction. Also, for the first time in a year, US corporate profits after tax increased, albeit only by 1.1%. The figure is a vast improvement on the 10.7% slump seen in the prior quarter and surpassed the consensus Q1 forecast of a 7% fall. Dissecting the Q1 GDP figures more closely, weakness in exports more than off-set a stabilisation in consumer spending, which accounts for around 2/3rds of US economic activity. Interestingly, some very competent market analysts are putting their neck on the block and are predicting much shallower weakness in Q2 and a return to positive US GDP growth in Q3. Unfortunately, unemployment is a lagging indicator so the US economy is likely to suffer rising jobless claims for some time yet even when the wider economy has returned to growth. The current unemployment rate is 8.9% and looks set to reach 10%, with the car manufacturing sector and Michigan, its home, likely to suffer most.
The growing expectation of H2 2009 economic recovery, and the view that equities were grossly oversold, prompted the sharp appreciation of equity prices in the period from early March to mid-May. At the end of that 10 week rally we highlighted that in the short-term prices look stretched after such a short sharp spike and a pause in upward momentum was inevitable. 2 weeks later that pause appears to be coming to a conclusion and the next move in the S&P 500, the diversified large cap index, is imminent. Based on the current trend of improving economic data and index technical factors we suggest the next significant move is up. The S&P 500 is at 907 (at the time of writing) from a March low of sub 700 and a further rise to near 1,000 would likely complete the technical recovery from the manic depressive state in investor confidence that caused the oversold trough in prices seen in March. A summer lull in trading may interfere with the timing of this view, but the next major move for US equities, we believe, is up. Time will tell.
We briefly mentioned oil. It’s worth taking a closer look at the market as the recent price action, we suggest, is a fore-taste of further inflationary pressures to come in other areas of the global economy. Reflecting for a moment, a barrel of oil fell from $147 during mid-2008, to a little over $32 by December of the same year. Since then oil has pursued a near-relentless recovery to pass $65 on Friday, twice its cyclical low. Statements from OPEC members have reinforced the view that the current rally is not a false dawn for oil bulls. The Saudi Arabia Oil Minister, Ali al-Naimi, long respected for moderate and reasonable analysis of the sector commented the market is “ready” for $75-$80 per barrel prices later in 2009. His views are based on already firming Asian, Middle Eastern and Latin American demand, not pie-in-the-sky guess work. The start of the US holiday driving season also suggests we are more likely to see $80 than $50, next. From a technical view, the price of oil has crossed its 200 day moving average and a number of oil analysts are now suggesting $60 is the new floor in prices. Politicians who side-lined their pro-green sound bites through the worst of the recession will soon be marketing their renewable energy credentials again.
Before progressing on to the UK, let’s take a brief look at the Euro-Zone economy where investment ‘professionals’ are still talking about deflation following release of May’s data which showed prices flat at 0.0% compared to the same month a year earlier. Readers will be forgiven for being confused. “Haven’t I just read oil prices have doubled and the global recession is definitely easing?” You did. But the Euro-zone is different to the US and other economies because the European Central Bank executed a monetary easing plan that was so mistimed (late) you would be forgiven for thinking they were trying to pre-empt the next recession, not cure this one. Not only were the box-tickers at the ECB too late in cutting rates, they unbelievably were still raising interest rates in July 2008 when corporate confidence had already stalled and seasoned financial sector analysts were busting blood vessels in stress as we approached the near-collapse of the global banking industry.
Allen Charles 10:40 pm on June 23, 2009 Permalink |
You fail to understandthat the money creation is for one reason and only the reason is a special CLASS of folks that become very wealthy being paid back for all the debt created by our debt based economy. All the other reasons is just so much hype. The money creators have from the begining profited by the special of storing one dollar and then being able to create nine more dollars that they they loan and enjoy the returns from their lending.
tradinghelpdesk 7:53 am on June 24, 2009 Permalink |
Allen, I agree with you totally. I was just trying to explain the economic reasons why lending and overly expansive monetary policies cause price bubbles. Whether the underlying motive of banking decision makers was greed, incompetence or a lack of regulatory supervision was up to the reader to decide.