Saturday, June 4, 2011

Policymakers have made another Depression Unavoidable

Equities markets have been battered all week by bad economic data sending investors piling into "risk free" Treasuries. The Dow Jones slipped 276 points on Wednesday followed by a 41-point loss on Thursday. The benchmark 10-year Treasury has ducked below 3 percent, repeatedly signaling a slowdown that could lead to another recession.

On Wednesday, the S&P/CaseShiller home-price index confirmed that the five-year long housing crash was still gaining pace. Home prices have fallen to their lowest level in eight years with no end in sight. Meanwhile the Chicago Manufacturing Gauge recorded its biggest decline in 2.5 years while factory orders dropped in April by the most since May, 2010. There was also bad news on the unemployment front where privately-owned businesses hired only 38,000 workers from April to May, nearly 100,000 less jobs than analysts had predicted. Also, consumer confidence fell to its lowest reading in six months.

So, housing, manufacturing, unemployment and consumer confidence are all down, down, down and down.

Friday's unemployment report was also worse than expected. The Bureau of Labor Statistics (BLS) reported that unemployment rose to 9.1 percent while the Labor Force Participation Rate remained stuck at 64.2%, well below the normal rate of 67%. According to Calculated Risk, "The current employment recession is by far the worst recession since WWII in percentage terms...(The BLS report) was well below expectations for payroll jobs, and the unemployment rate was higher than expected."

So, no new jobs are being created and the economy is quickly decelerating. It's all bad.

On Friday, the chairman of RIT Capital Partners Jacob Rothschild issued a warning about the fragility of world markets and the bleak prospects for future growth. He said, "The risks ahead are glaring and global. It is likely that the withdrawal of the fiscal and monetary stimuli which will surely come soon will have an impact on global growth. Indeed there is already evidence of some slowing down."

Commodities have already been walloped, but the real carnage is yet to come. This is from Bloomberg:
"Commodities plunged yesterday as investors accelerated sales following year-to-date gains through April of more than 23 percent for silver, oil, gasoline and coffee. The Standard &Poor's GSCI index of 24 commodities sank 6.5 percent in the biggest one-day drop since January 2009, bringing its loss this week to 9.9 percent.

"It was a train wreck waiting to happen," Michael Mullaney, portfolio manager at Boston-based Fiduciary Trust, said in a telephone interview. Speculation drove commodity prices well above reasonable levels, "and we are going to see it shake out some more before we get back to normal prices," said Mullaney, who helps manage $9.5 billion."
Even a whiff of deflation will send commodities tumbling, which is why investors should be worried about the recent data. The economy is quickly losing steam and troubles in China, Japan and the eurozone have only added to the uncertainty. According to Bloomberg:
"A 'sudden' slowdown in China may lead commodity prices to fall as much as 75 percent from current levels, Standard &Poor's said. Unexpected shifts in government policies or problems in the banking sector may trigger such a slowdown, S&P said in a report e-mailed today....."Given the extent to which China has bolstered commodity prices, that's something that we have to be concerned about," S&P analyst Scott Sprinzen said by telephone from New York."
The fact that 10-year Treasuries have dipped below 3 percent should also be of concern, because it's an indication that the policy is wrong. This is the real problem. When investors are still so scared that they're still loading up on "risk free" assets a full three years after the crisis began, then something is fundamentally wrong. The 10-year is saying quite clearly, "Whatever you are doing is not working, so stop it."

The Fed's bond-buying program (QE2) has done nothing to increase activity, lower unemployment, stimulate growth, restore confidence or expand credit. It has been the biggest policy bust in Fed history, and now the economy is slipping back into a coma.

Remember, the economy is not a sentient being. It does not consider whether a policy is good or bad. Like any system it merely responds to input. If spending increases, incomes will increase, demand will increase, employment will increase and the economy will grow.

Conversely, contractionary policies are contractionary. This is something the deficit hawks don't seem to grasp. If you slash government spending, lay off workers, and trim the deficits, then spending will slow, incomes will shrivel, GDP will wither, and the economy will slip back into recession. In other words, if you take steps to shrink the economy, then the economy will shrink. This is why the economy has lost momentum, because congress and the White House have cut the blood flow of stimulus to the patient, so now we are headed back into ICU.

The Republican mantra, "job killing stimulus," is an oxymoron like "military intelligence" or "jumbo shrimp." It is idiocy squared. The economy needs stimulus because stimulus IS spending...government spending. And, as we noted earlier, the economy does not care "who spends"; it merely responds to input. And the input that's needed now is more spending. Government spending will do just fine.

Consumers are still deleveraging from the losses they sustained during the financial crisis, so they've cut back on their borrowing and spending. This creates a problem, because consumer spending represents 70% of GDP. So if consumers don't load up on debt again, there will be no recovery. (Every recovery since WW2 has been the result of a credit expansion.) This is why Fed chairman Bernanke has tried to induce more borrowing by lowering rates to zero and buying US Treasuries from the banks (which, in effect, creates negative interest rates) But it hasn't worked. Negative rates have not sparked another credit expansion because there are times when people will not borrow regardless of the rates or the inducements. John Maynard Keynes figured this out more than 80 years ago, but Bernanke has "unlearned" the lessons of the past. As a result, we are headed for another slump.

Consumers aren't spending, businesses aren't investing, and credit is not expanding. At the same time, state and federal governments are trimming budgets and laying off workers. So, all the main players are cutting, cutting, cutting. Naturally, the economy has responded in kind; housing prices are falling, unemployment is rising, manufacturing is stalling and consumer confidence is dropping.

There's nothing here that should surprise us. We are headed into a Depression because policymakers have made another Depression unavoidable. A policy-driven Depression is different than a financial crisis. It is a matter of choice. It means that the objectives of the people who control the system are different than our own. There are those who will benefit from another severe downturn, but most of us will only needlessly suffer.

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