| | Friday, August 5, 2011 | | .................................................................................................
|  | | | | Flash Crash Lite | | 500+ Points In the Red... and Still A Ways To Go |
The Dow Jones Industrial Average plummeted more than 500 points yesterday -- plunging the Blue Chip index into the red for 2011...and plunging a dagger into the hopes that the "debt ceiling" vote would put a floor under the stock market.
No one really has any idea why the stock market tanked yesterday, but almost everyone has an explanation. Some blame Europe, others cite signs of economic weakness here home, and still others link the falling stock market to "generally gloomy conditions."
Jeff Macke, writing for Yahoo Finance, summarizes the situation fairly succinctly:
There's a growing realization among even the most optimistic investors that the United States is entering a new recession -- a dreaded "double-dip." Adding to the pain is the sense that the government and Federal Reserve are out of both ideas and ways to stimulate the economy. Corporate America is sitting on record amounts of cash but is refusing to make new investments with so little end demand for its products. Consumers and corporations are hoarding cash, and the economy appears to be seizing. The debt ceiling debate was a fiasco, snuffing any remaining confidence traders had for help from Washington, D.C.
The bottom line is traders are becoming convinced that we're facing a prolonged and severe recession, and there's nothing any government on Earth can do to stop it. In that context, selling stocks or "reducing exposure" as they say on Wall Street, is quite rational. Or at least not completely irrational...
Here at the Daily Reckoning, we will advance no explanations for the mini-panic that is underway. Instead, we will merely observe that a sluggish U.S. economy and a fracturing European economic union provide little incentive to buy stocks.
But as lethargic as the US economy has been, and as uninspiring its stock market, the US looks like a rock alongside its European counterparts. For example, even though the Dow finally dipped into negative territory for the year-to-date yesterday, most European markets are down double-digits for the year.
Doing "better than bad" is small comfort, but it is some comfort. The poorly performing European stock markets reflect both widespread economic anemia and deteriorating public finances in several European countries.
Fifteen years ago, Morgan Stanley's Investment Strategist, Byron Wien, quipped, "Unless Europe engages in an extensive program of restructuring, in 20 years it will be a vast open-air museum."
Europe is not a museum...yet, but it might want to begin interviewing prospective docents. The European private sector is growing slowly, if at all, while the public sector is struggling mightily to pay its bills. Signs of economic distress in the old World are increasing by the day. Some call it "Eurosclerosis." The pricing of credit default swaps (CDS) provides some insight.
A CDS, as regular readers may recall, is a kind of insurance. The greater the perceived risk of default, the higher the CDS price. Lately, the prices of European CDS are soaring -- both on corporate debt and on government debt. And European CDS prices are not simply rising in absolute terms, but also in relation to CDS prices of comparable credits in America and elsewhere.
Try to stay with us here...
The chart below compares an index of CDS prices on 125 large European corporations with an index of CDS prices on 125 large American corporations. (When the chart is red, US CDS are more expensive than European CDS. When the chart is green, European CDS are more expensive).
Three years ago, during the crisis of 2008, American CDS were more expensive than European, meaning the market considered American corporations to be riskier credits than European ones. Today, the pricing relationship has reversed completely. European CDS are more expensive than American CDS.
This trend is not entirely surprising, given the serious fiscal crisis that is unfolding around the periphery of the euro zone. The following chart, by contrast, is something of a shock.
The price of a CDS on 5-year French government bond, which is rated AAA, is much higher than the price of a CDS on a 5-year Chilean government bond, which is only rated A+. In other words, the CDS market is saying Chile is a much better credit risk than France.
Does the CDS market know something that all those smart guys at the credit rating agencies don't know? Does the CDS market suspect that the "strong economies" of the West are not as strong as their reputations would suggest? Does the CDS market see that the global financial hierarchy we have today will not be the same hierarchy we will have tomorrow?
The world economy is changing right before our eyes, dear reader. Don't let it change without you.
In today's edition of the Daily Reckoning, guest columnists, John Mauldin and FrederickSheehan, share two troubling vignettes from the real world that illustrate how the global financial hierarchy may be shifting already... | | | | | | | | | | | | | | | | | | | The Debt Supercycle | | It started when a friend gave Senator Dan Coats a copy of Endgame. He read it and underlined, highlighted, and scored it. The Senator Rob Portman took it off his hands and read it. They asked me to come to DC and meet a few Senators. You don't say no to such a request...
I flew to Washington and met with nine of them for about 90 minutes and Senator Cornyn (from Texas) privately beforehand for an hour. I offered him a copy of the book, but he said he was already reading it on the iPad he was carrying. I gave him one anyway. ;-)
Evidently, Coats and Portman had worked the room, because nine guys showed up more or less on time. Two Democrats, six Republicans, and an independent (Lieberman). Jon Kyl was there, as well as Gang of Six member, Tom Coburn from Oklahoma. Also Corker, Lugar, Coats, Portman, and Mike Lee, the Tea Party senator from Utah, who took the most notes. But there were a lot of them taking notes. And asking questions, some rather pointed.
Overall, I was very impressed with the level of knowledge in the room and the candor.
I started by explaining what I meant by the debt supercycle and how deleveraging recessions are fundamentally different from business-cycle recessions, which is why we are not seeing a normal recovery. And it is happening all over the developed world.
I think I surprised them by jumping to Europe first, noting that Europe appeared to be imploding even as we were meeting. I made the point that we could see a banking and credit crisis coming from Europe that might be worse than the subprime crisis. I noted that it was not just Greece, Ireland, and Portugal. Spain and Italy have their own share of problems, and the markets have taken their interest rates up by 1% in just the last month, just as a large rollover of debt is coming due.
Italy's average debt duration is quite short, as illustrated in the chart below. (Thanks to London partner, Niels Jensen, for bringing this fact to my attention). Within Europe, only the UK has really long average debt duration (about 13 years). Most countries are averaging 5-7 years. Italy is no exception.
Then today I get this note from Bluemont Capital Advisors, written by Harald Malmgren, Global Economic Strategist, and Mark Stys, Chief Investment Officer. It is short but important, so I am going to quote it liberally:
Italian and Spanish interbank lending is freezing up. French Finance Ministry officials and banks have been in emergency meetings regarding Eurozone interbank market stress. IMF and EU officials are warning that France might also face downgrade if greater spending cuts are not made. Finance Ministry staff have been warned to be available 24/7 (irrespective of sacred August holidays!), as contagion may soon affect French banks and sovereign debt.
Italian and Spanish sovereign debt yields have resumed escalation this week. Moreover, the Italians had to cancel issuance of longer maturity debt, as demand was insufficient...
Meanwhile, US money market funds have been withdrawing from Eurozone bank commercial paper, leaving Eurozone banks with a big gap in availability of short-term funding and a severe shortage of dollars.
In the background, the Fed has quietly advised the ECB and some other central banks that Congress has warned the Fed not to repeat the huge liquidity support to Europe and Asia that it provided in 2008. European officials believe the Fed would be less able to come to the rescue again with increased swap lines and direct loans to Eurozone banks, as it did post-Lehman.
Thus, the Eurozone appears to be entering into renewed crisis of breakdown in interbank trust and escalating borrowing costs for Italy and Spain, and maybe even France...It is increasingly possible that the ECB may not be able to function as lender of last resort on the scale required to cope with an interbank lending breakdown.
Demand for dollars will likely escalate, while confidence in Eurozone financial institutions falls. This could force Eurozone banks to purchase dollars in the open market and drive the dollar higher.
I made some similar points to the Senators about why the euro is going to parity if it survives. Then I went into my "Japan is a bug in search of a windshield" spiel, pointing out that the yen will fall in half.
All this to say is that the bond markets are going to get spooked sooner than we are prepared for. If the US does not show up with a credible deficit-reduction program by the end of 2013, we could see interest rates rising even in the face of a deflationary recession. If we do nothing, we become Greece.
We need $10-12 trillion in cuts over ten years, which I explained would put us into a slow-growth-at-best, muddle-through economy with high unemployment and tough tax policies. I pointedly showed Senator Mike Lee why we could not cut spending too fast (as the Tea Party wants) unless we want "Depression 2.0" and 20% unemployment. It has to be my glide-path option.
It was a very sober group as we ended the meeting. They all politely thanked me for coming and talking frankly. But the Senators made it clear that cutting spending in a meaningful way was going to be very hard, and would take real commitment from them to get us through this. They all noted that their mail was running 100 to 1 against cutting Medicare. Every one of them.
They know that they cannot close the deficit gap just with the elimination of the Bush tax cuts. We are at an impasse. We need a massive restructuring of our entire tax code to be more encouraging of creating jobs. But that is another story for another week.
| | | | | | | | | | | Debt to GDP in the US surpasses 100% | Investors were staggered yesterday. Stocks got walloped.
Dow down 512 points.
Today, bond yields are falling... oil is below $86. London, Paris, Frankfurt -- all down heavily. Only gold has resisted the general rout. It lost only $7 yesterday.
Why?
The reason is debt. It won't go away. It won't say 'adios' and get on a bus. Like a bad houseguest, it won't leave!
The feds have tried to ignore it. They've tried to postpone it. They've tried make the problem go away by stimulating the economy to grow faster.
But nothing has worked. Day by day the debt grows larger... And day by day, the moment of truth grows closer.
What truth?
That you can't make excess debt disappear. It has to be paid...either by the borrower, or by the lender. Someone has to suffer.
Why is that? Because borrowing takes from the future. Sooner or later, the future shows up and wants to be paid. It wants its 'pound of flesh.' Its recompense. It wants what is due.
Yes, dear reader, a high speed train may have changed the world of travel. The invention of Viagra may have changed man's love life. And don't forget Facebook; it's had a big effect on social life. All around us is Progress with a capital 'P'!
But where is the progress in the world of money? How is debt today any different from debt 1,000 years ago? How are bankers' mistakes any different? They lent too much to the wrong people in the time of Caesar; they make the same mistakes today.
And what about money itself? There was good money back then...and bad money. Good debts, and bad debts. Good investments and bad investments.
The life of money never changes. It's not a technical system, in which progress is made. It's a moral system, in which the same lessons get learned over and over again.
The lesson investors are learning now is that there are bear markets as well as bull markets. Stocks go down as well as up, in other words. And sometimes, a downturn in the stock market is not a buying opportunity...it's just a step on a long stairway to Hell.
It's too early to know whether yesterday's big drop was a step down the bear market staircase...or just a feint...or just an emotional reaction to bad news -- or all of the above. So, let's turn back to what we do know for sure: there's too much debt in the system; it's gotta go away somehow.
Tuesday, the US hit a landmark. It joined the Losers Club. Here's the report:
The United States Public Debt Surpasses its Gross Domestic Product
By Zachary Keck, DC Foreign Policy Examiner
On Tuesday the United States net public debt to GDP ratio reached 100%. That is, the federal government's accumulated debt is equal (actually surpassed) the United States Gross Domestic Product in 2010.
After Congress and the Obama administration passed the debt ceiling limit, the Treasury borrowed $238 billion on Tuesday. This brought public debt to $14.58 trillion dollars, slightly higher than the United States GDP in 2010, which was $14.54 trillion.
Richard Haass, the President of the primer Foreign Policy organization, the Council on Foreign Relations President, has repeatedly argued that the nation's growing debt is the greatest national security threat the country faces. As Yale diplomatic historian Paul Kennedy has convincingly demonstrated, the rise and fall of great powers since the time of the Roman Empire has been driven by the economic vitality of the country. Countries that aren't economically dynamic can't maintain large military. Traditionally, the red line has been when debt-to-GDP ratio reached 90%. At this level, it was difficult to reign in debt as growth remained stagnant if not decreased altogether. 100% is therefore quite worrisome indeed.
It's also worth looking at which countries that puts the United States in a league with. According to Agence French-Presse the only countries besides the United States to have a public debt-GDP ratio of 100% are "Japan (229 percent), Greece (152 percent), Jamaica (137 percent), Lebanon (134 percent), Italy (120 percent), Ireland (114 percent) and Iceland (103 percent)."
And more thoughts...
*** Larry Summers is talking about a "double dip" recession. He's wrong twice. First, because there was no recession. Second, because there won't be another one anytime soon. This is a correction, not a recession.
A recession is a different thing. In a recession, an economy takes a break...it's like pulling into a rest stop along the highway. You fill up your gas tank, and you can start out again.
But what began in 2007 was no rest stop. It was a complete stop. Time to check the map. Change direction.
David Rosenberg explains:
Plain-vanilla, garden-variety business expansions and contractions that are influenced by the manufacturing inventory cycle tend to have recessions separated between five and 10 years apart. That was certainly the experience that economists came to understand and appreciate in the post-WWII era...
This time, we are dealing with something different. This is a balance-sheet downturn...when businesses and households begin paying down debt and rebuilding the asset side of their balance sheets. Instead of spending...they save.
It is a very natural thing to do, but it hasn't happened in 80 years. And it changes the whole nature of the economy. The US economy has developed to provide goods and services to household spenders. That's why there are so many malls in America -- 10 times as much retail space per person as in France, for example. And that's why a large percentage of the US population is employed in "service sector" jobs -- lending, selling, installing, maintaining and otherwise helping households spend money. Manufacturing may have declined in America, but at least there was the service sector.
What happens when households stop spending? Time to check the map! And change direction.
The latest jobs report shows that even the service sector is no longer creating new jobs like it used to. And no wonder. Consumer spending is slumpy. It hasn't been so weak since WWII. And it actually went down last month.
Considering that population and price levels are still going up, an actual decline in consumer spending is a sign that the Great Correction is intensifying.
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